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TRUST AND RELIANCE—ENFORCEMENT AND COMPLIANCE ENHANCING CONSUMER

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					Please cite to this location: http://www.law.stanford.edu/library/biblio/rufus.pdf
  Feel free to contact the author at rufus.pichler@stanfordalumni.org




TRUST AND RELIANCE—ENFORCEMENT AND COMPLIANCE:

           ENHANCING CONSUMER CONFIDENCE IN THE

                        ELECTRONIC MARKETPLACE




                                        A THESIS

                                  SUBMITTED TO THE

        STANFORD PROGRAM IN INTERNATIONAL LEGAL STUDIES

                        AT THE STANFORD LAW SCHOOL,

                               STANFORD UNIVERSITY

             IN PARTIAL FULFILLMENT OF THE REQUIREMENTS

                                FOR THE DEGREE OF

                          JURIDICAL SCIENCES MASTER




                                             By

                                      Rufus Pichler

                                        May 2000
                                   ABSTRACT

Consumers will not engage in impersonal exchange unless they either trust the

merchant they are dealing with and believe that everything will go alright or they

can comfortably rely on a third party to effectively afford them redress if things go

wrong. Trust and reliance, which are to a large extent grounded on expected

compliance and effective enforcement, are two distinct components of consumer

confidence. This paper discusses why traditional bases for trust and reliance are

no longer effective in the electronic marketplace. It argues that new institutions

will emerge to enhance trust and reliance, namely information intermediaries and

payment intermediaries, respectively. Of these two options, reliance mechanisms

that can guarantee cheap and effective enforcement of consumer rights

ultimately appear to be the more efficient approach to overcome the existing lack

of consumer confidence.


The paper shows that some of these reliance mechanisms have developed in the

market and it points out the crucial role of payment intermediaries in every online

transaction. From a policy perspective it suggests to leverage this role and to

consider addressing payment intermediaries by introducing comprehensive

chargeback regimes that could guarantee effective consumer redress if

something goes wrong in the transaction between a merchant and a consumer.


In their “Framework for Global Electronic Commerce” Bill Clinton and Albert Gore

have emphasized that “consumers must have confidence ... that they will get

what they pay for, and that recourse or redress will be available if they do not.”

                                         ii
Chargeback mechanisms appear to be a tool that can guarantee the latter.

Therefore the paper argues that they are an approach worth pursuing in order to

overcome “the global enforcement challenge” presented by the new online

marketplace.




                                      iii
                                  PREFACE

First, I wish to thank the faculty of Stanford Law School, particularly Carey

Heckman and Rogelio Perez-Perdomo, who have provided valuable suggestions

and comments on previous drafts of this thesis. Stanford University in the heart

of Silicon Valley is probably the most stimulating environment in the world for

working on a topic related to electronic commerce. In such an environment it is

difficult to acknowledge everybody who influenced the thinking that is expressed

in this paper. To name a few though, I want to mention Peggy Radin, Mitch

Polinsky, and Paul Goldstein. Their courses at Stanford Law School were great

fun and provided numerous invaluable suggestions for my work.


I also owe thanks to my parents and the Studienstiftung des Deutschen Volkes

whose financial support has helped to make this research possible and to Kate

DeBoer who, among other things, directed me to the best Bed and Breakfast in

Sonoma Valley when I needed to get out of here.


Finally, I want to express my gratitude to the staff of the Stanford University

libraries, particularly the Robert Crown Law Library. Researchers can’t wish for

better support than what I have experienced here.




                                       iv
                                                         CONTENTS

I.         Introduction....................................................................................................1

II.        The Online-Marketplace: Shaking the Foundations of Consumer Confidence

           .......................................................................................................................8

      A.        Some Characteristics and Risks of Distance Transactions ........................9

           1)        Security and Consumer Fraud..............................................................13

           2)        Merchant Fraud and Consumer Redress .............................................23

      B.        What is “Consumer Confidence”? ............................................................32

           1)        Trust and Reliance ...............................................................................34

                a) Trust .....................................................................................................35

                b)      Reliance ............................................................................................44

                c) Some Economics of Trust and Reliance...............................................46

           2)        Enforcement and Compliance ..............................................................51

      C.        Enforcement and Compliance in the Online-Marketplace ........................54

           1)        Third Party Enforcement.......................................................................56

                a) State Enforcement................................................................................57

                     aa) The Federal Trade Commission and the Attorneys General .........60

                        α)Enforcement Efforts Regarding Electronic Commerce ..................66




                                                                  v
       β) The Limits of State Enforcement and Their Implications for

       Consumer Reliance ..........................................................................69

          αα) Limited Enforcement ..............................................................70

          ββ) Limited Reliance.....................................................................75

     bb) The European Approach and Criminal Proceedings .....................79

b)     Court Enforcement............................................................................81

     aa) Suits Brought by Individual Consumers.........................................82

       α)Some Economics of Consumer Litigation......................................82

          αα) Benefits ..................................................................................83

          ββ) Costs ......................................................................................87

       β) “The Consumer’s Dilemma”...........................................................89

     bb) Rights to Sue for Consumer Organizations ...................................92

       α)Collective Interests of Consumers.................................................94

       β) Individual Interests of Consumers .................................................96

c) Organization Enforcement and Codes of Conduct (Self-Regulation)....97

     aa) Historic Examples of Successful Industry Self-Regulation ..........101

     bb) It’s a Different World Online—The Failure of Self-Regulation as a

     Basis for Consumer Reliance .............................................................104

d)     Informal Enforcement of Social Norms ...........................................109


                                                vi
       2)        Compliance ........................................................................................112

            a) Experience (Bilateral Reputation Mechanism)....................................113

            b)      Reputation (Multilateral Reputation Mechanism) ............................115

            c) ... And Those Who Don’t Care............................................................119

  D.        From Compliance to Trust?....................................................................121

       1)        Information .........................................................................................122

       2)        Time ...................................................................................................125

       3)        Investment and Branding....................................................................126

  E.        Who Gets Left Behind? ..........................................................................132

  F.        Summary—The Need for New Institutions .............................................138

III. Enhancing Consumer Confidence: The Rise of New External Institutions.141

  A.        New Institutions to Foster Trust—Information Intermediaries ................142

       1)        The Approaches .................................................................................143

            a) BBBOnline Reliability Program ...........................................................143

            b)      CPA WebTrust ................................................................................144

            c) Bizrate, eComplaints, and e-Rating ....................................................145

       2)        The Limits...........................................................................................147

  B.        Reliance on New Enforcement Institutions—The Crucial Role of Payment

  Intermediaries ...............................................................................................150

       1)        Market Approaches ............................................................................151
                                                              vii
           a) Escrows ..............................................................................................151

           b)       “Blue,” Shopping Guarantees, and Insurance .................................153

      2)        A    Policy     Perspective—Addressing                  Payment          Intermediaries          and

      Introducing Chargeback Mechanisms........................................................154

           a) Chargebacks in U.S. Credit Card Regulation .....................................154

           b)       Chargebacks as a General Enforcement Model .............................155

IV. Conclusions ...............................................................................................158




                                                          viii
                                                                                 Introduction




I.       INTRODUCTION

“Despite all of the sound and fury, business to consumer commercial online

transactions are but in their earliest stages.” Just over a third of Internet users

report that they actually make purchases online. These are some of the key

findings of a recent study by the Stanford Institute for the Quantitative Study of

Society.1 This paper will argue that this relatively poor performance of business-

to-consumer electronic commerce is due to a lack of consumer confidence and

that new institutions are needed to overcome this deficit.


Various private and public institutions hopelessly disagree about how much

wealth electronic commerce can potentially generate. According to one

comparison the 1995 estimates of e-commerce revenues in the year 2000

ranged from $580 million to $775 billion2—more than 1000 times the lower

estimate (a discrepancy that presumably accounts for the use of the term




1
  See Norman H. Nie & Lutz Erbring, Stanford Institute for the Quantitative Study of Society,
Internet    and      Society:     A    Preliminary    Report      4     (Feb.    17,    2000)
<http://www.stanford.edu/group/siqss/Press_Release/Preliminary_Report.pdf >. See also SIQSS,
Internet         Study          (last        modified          Feb.          18,        2000)
<http://www.stanford.edu/group/siqss/Press_Release/internetStudy.html> (providing background
information on the study); Kathleen O’Toole, Study takes early look at social consequences of
Net        use,       STANFORD        REPORT        [ONLINE]        (Feb.      16,      2000)
<http://www.stanford.edu/dept/news/report/news/february16/internetsurvey-216.html> (reporting
on the study).
2
  See OECD, Committee for Information, Computer and Communications Policy, Measuring
Electronic Commerce, OCDE/GD(97)185, table 2 at 24-25 (containing comprehensive tables with
a comparison of various electronic commerce estimates by Hambrecht & Quest, Forrester
Research and many others). See also OECD, THE ECONOMIC AND SOCIAL IMPACT OF ELECTRONIC
COMMERCE: PRELIMINARY FINDINGS AND RESEARCH AGENDA table 1.1 at 27 (1999) [hereinafter
OECD, THE IMPACT OF ELECTRONIC COMMERCE] (presenting yet different figures).

                                             1
                                                                                      Introduction


“guesstimate” in similar contexts).3 Virtually every source provides different

figures. Some forecast that the one trillion-dollar threshold will be crossed by

2003.4 In fact, it is even far from clear how to define,5 let alone how to accurately

measure electronic commerce.6 This probably accounts for the fact that not only

can one find significant differences in future estimates, but also in ex post

statistics on electronic commerce returns.7 According to one comparison the



3
  See, e.g., Michael Froomkin, The Essential Role of Trusted Third Parties in Electronic
Commerce, 75 OR. L. REV. 49, 68 (1996).
4
  See U.S. GOVERNMENT W ORKING GROUP ON ELECTRONIC COMMERCE, TOWARDS DIGITAL
EQUALITY,      SECOND       ANNUAL  REPORT     at     iii,  7    (1999),     available at
<http://www.ecommerce.gov/ecomrce.pdf> [hereinafter W ORKING GROUP II]. See also U.S.
DEPARTMENT OF COMMERCE, THE EMERGING DIGITAL ECONOMY (1998), available at
<http://www.ecommerce.gov/EmergingDig.pdf> [hereinafter DIGITAL ECONOMY I]; U.S.
DEPARTMENT OF COMMERCE, THE EMERGING DIGITAL ECONOMY II (1999), available at
<http://www.ecommerce.gov/ede/ede2.pdf> [hereinafter DIGITAL ECONOMY II]; U.S. GOVERNMENT
W ORKING GROUP ON ELECTRONIC COMMERCE, FIRST ANNUAL REPORT (1998), available at
<http://www.doc.gov/ecommerce/E-comm.pdf> [hereinafter W ORKING GROUP I] (all providing
measurements and estimates of electronic commerce as well as a general and comprehensive
analysis of the digital economy).
5
  For a good overview on various definitions of Electronic Commerce see OECD, Measuring
Electronic Commerce, supra note 2, at 6 Box A, 19 Figure 1. The OECD’s own working definition
of electronic commerce in that paper is that of “commercial transactions occurring over open
networks, primarily the Internet.” See id. at 9.
6
  The OECD has taken on the task to develop ”E-commerce statistics that are internationally
comparable, and therefore based on a common set of definitions and a common measurement
framework for e-commerce.” (See OECD, Directorate for Science, Technology and Industry,
Committee for Information, Computer and Communications Policy, Working Party on Indicators
for the Information Society, Defining and Measuring E-Commerce: A Status Report,
DSTI/ICCP/IIS(99)4/FINAL at 6 (Oct. 7, 1999). See also OECD, Measuring Electronic Commerce,
supra note 2; OECD, Directorate for Science, Technology and Industry, Committee for
Information, Computer and Communications Policy, Working Party on the Information Economy,
Measuring Electronic Commerce: International Trade in Software, DSTI/ICCP/IE(98)3/FINAL
(April 27, 1998) [hereinafter OECD, Measuring Trade in Software]. Meaningful measurement of
the Digital Economy is also one of the U.S. government’s primary objectives, see W ORKING
GROUP II, supra note 4, at vi, 23-25 (referring to president Clinton’s 1998 directive on electronic
commerce; this Directive has led the reports DIGITAL ECONOMY I and II, supra note 4).
One of the most influential factors is, whether or not the estimates distinguish between business-
to-business and business-to-consumer e-commerce. The volume of the first greatly exceeds that
of the latter, see, e.g., OECD, Measuring Electronic Commerce, supra note 2, at 3. See also infra
note 10.
7
  According to OECD, Measuring Electronic Commerce, supra note 2, at 7, “[a]ll estimates of
electronic commerce activity are based on revenues, not value added, ....”. See also Maryann
                                             2
                                                                                       Introduction


1995 figures for actual electronic commerce revenues ranged from $45 million to

$1.17 billion.8


In one regard, however, everybody seems to agree:9 It should be more. Indeed,

some say that e-commerce—and one should be more specific and say business-

to-consumer e-commerce10—so far has not met the expectations at all,11 at least

not in all parts of the world.12 The more optimistic ones concede a great danger




Jones Thompson, Spotlight: Why E-commerce Forecasters Don’t Get It “Right”, The Standard
(Mar. 1, 1999) <http://www.thestandard.com/research/metrics/display/0,2799,9881,00.html>.
8
    See OECD, Measuring Electronic Commerce, supra note 2, table 2 at 25.
9
 With the exception, of course, of those who generally oppose and regret the commercialization
of the Internet (particularly the World Wide Web), wishing to return to old times in which the net
was a social rather than a commercial space and the users were a more or less homogenous
group sharing common values. For good accounts of how “the net used to be” (or at least was
perceived to be) see, e.g., CLIFFORD STOLL, SILICON SNAKE OIL (1995); SHERRY TURKLE, LIFE ON
THE SCREEN: IDENTITY IN THE AGE OF THE INTERNET (1995); HOWARD RHEINGOLD, THE VIRTUAL
COMMUNITY: HOMESTEADING ON THE ELECTRONIC FRONTIER (1993); MANUEL CASTELLS, THE RISE OF
THE NETWORK SOCIETY 342 passim (1996) and the various articles in HIGH NOON ON THE
ELECTRONIC FRONTIER (Peter Ludlow ed., 1996).
The process of commercialization has been vividly described by Robert L. Dunne, Deterring
Unauthorized Access to Computers: Controlling Behavior in Cyberspace Through a Contract Law
Paradigm, 35 Jurimetrics J. 1, 8 (1994) as “the [then] relatively recent influx of ‘immigrants‘ from
the real world who are arriving in droves in the belief that cyberia’s highways are paved with
gold.”
10
   The distinction between business-to-business and business-to-consumer e-commerce is vital,
since both segments are driven by different factors and face a number of completely different
barriers. For a good summary of the different issues each of these segments is facing see OECD,
THE IMPACT OF ELECTRONIC COMMERCE, supra note 2, at 37, 42 (listing drivers and inhibitors of
business-to-business and business-to-consumer e-commerce, respectively). See also DIGITAL
ECONOMY I, supra note 4, at 12 passim, 24 passim; W ORKING GROUP II, supra note 4, at 5-8;
OECD, Measuring Electronic Commerce, supra note 2, at 11-13 (all emphasizing the distinction
between the two segments); DIGITAL ECONOMY II, supra note 4, 10-12 (speaking of “retail e-
commerce” and business-to-business e-commerce).
11
  Of course one has to take into account, that some of the estimates (see supra note 2) seemed
highly exaggerated in the first place. Those that refer to lower estimates in the first place found
that the expectations for 2000 (in this case being $7 billion) were exceeded in 1998, see
W ORKING GROUP II, supra note 4, at 6.
12
  See, e.g., DIGITAL ECONOMY II, supra note 4, at 6 (pointing out that “[c]ompared with businesses
and consumers overseas, U.S. businesses and consumers appear to have a greater desire and
willingness to transact business online.”). See also Dermot McGrath, When ‘E’ Stands for Europe,
                                                  3
                                                                                        Introduction


that expectations will not be met in the future.13 Everyone even seems to agree

on the principal reason that to date has prevented e-commerce from living up to

its full potential: a lack of consumer trust and confidence in the electronic

marketplace. This concern is expressed by all major policy papers and private

sector analyses. Consequently, these analyses define establishing enhanced

consumer confidence as their number one goal with regard to the further

development of electronic commerce. The following passage from the U.S.

Government’s Framework for Global Electronic Commerce is exemplary14 for the

prevailing view:




COMPUTERWORLD, Sept.6, 1999, at 52 (“Europeans are more reluctant than Americans to buy
online, ....”).
13
  See W ORKING GROUP II, supra note 4, at iv (“The robust projections for the growth of electronic
commerce are unlikely to hold true unless online consumers can shop the Web with
confidence.”).
14
    In additions to the sources cited infra notes 16, 17, and 20 see also The National Advisory
Council on Consumer Affairs (Australia), Consumer Protection in Electronic Commerce 2 (April
1998) (“foster public confidence in the electronic marketplace”), available online at
<http://www.treasury.gov.au/publications/ConsumerAffairs/ElectronicCommercePublications/Con
sumerProtectionInElectronicCommerce-PrinciplesAndKeyIssues/index.asp>; Global Information
Networks, Ministerial Conference Bonn 6-8 July 1997, Ministerial Declaration para. 29 (visited
Aug. 17, 00) <http://www2.echo.lu/bonn/final.htm> [hereinafter Bonn Declaration] (“Ministers
recognise that it is crucial to build trust and confidence in Global Information Networks ....”);
Consumers International, Consumers@shopping: An international comparative study of electronic
commerce                 7            (1999),              available             online            at
<http://www.consumersinternational.org/campaigns/electronic/e-comm.pdf> (“If consumers are to
take full advantage of the global shopping mall theoretically offered by the Internet, they must feel
confident of receiving a consistent standard of consumer protection wherever they shop.”);
OECD, Directorate for Science, Technology and Industry, Committee on Consumer Policy,
Consumer Protection in the Electronic Marketplace, DSTI/CP(98)13/FINAL at 4 (Dec. 22, 1998)
(“Direct business-to-consumer electronic commerce will not reach its full potential until consumers
are assured that the online environment is a safe and predictable place for them to do business.
.... Working together, governments, businesses and consumer representatives can help to
enhance consumer confidence in electronic commercial transactions while encouraging the
development of the global marketplace.”); OECD, Directorate for Science, Technology and
Industry, OECD Forum on Electronic Commerce: Report on the Forum, OECD, Paris, 12-13
October 1999, SG/EC(99)12 at 6, 14 (Nov. 24, 1999) (“Users must gain confidence in the digital
marketplace.”, “Trust is central to any transaction, electronic or otherwise.”).

                                                 4
                                                                                    Introduction


        “In order to realize the commercial and cultural potential of the Internet,

        consumers must have confidence that the goods and services offered are

        fairly represented, that they will get what they pay for, and that recourse or

        redress will be available if they do not.”15


Similarly, the European Commission stated that “[t]he first objective is to build

trust and confidence.”16 Speaking for the private sector the Alliance for Global

Business, representing business interest groups from around the world, has

made detailed recommendations on “[b]uilding trust for users and consumers.”17

And according to the Global Business Dialogue on Electronic Commerce

(GBDe)—characterizing itself as “an unprecedented world-wide collaboration

among leading CEO’s and board members of companies engaged in the field of

electronic commerce”18 and being characterized by the U.S. Government



15
   See W ILLIAM J. CLINTON & ALBERT GORE, JR., A FRAMEWORK FOR GLOBAL ELECTRONIC
COMMERCE at III.8. (1997), available at <http://www.ecommerce.gov/framewrk.htm> [hereinafter
FRAMEWORK]. See also W ORKING GROUP I, supra note 4, at 27 (containing an almost identical
formulation); W ORKING GROUP II, supra note 4, at 17 (“Consumers must be confident that the
goods and services offered online are fairly represented and the merchants with whom they are
dealing—many of whom may be located in another part of the world—deliver their goods in a
timely manner and are not engaged in illegal business practices such as fraud or deception.
Consumer confidence also requires that consumers have access to fair and effective redress if
they are not satisfied with some aspect of the transaction.”).
16
     See A European Initiative in Electronic Commerce, COM(97)157 final para. 35.
17
   See Alliance for Global Business, A Global Action Plan for Electronic Commerce: Prepared by
Business with Recommendations for Governments 20 passim (2d ed. 1999), available online at
<http://www.oecd.org//dsti/sti/it/ec/act/Paris_ec/pdf/bizac_e.pdf> (identical with OECD Doc.
SG/EC(99)6); (An earlier version of this paper was also submitted as a background document to
the OECD Ministerial Conference in Ottawa, Canada, Oct. 7-9, 1998. See OECD, Directorate for
Science, Technology and Industry, Steering Committee for the Ottawa Ministerial Conference “A
Borderless World: Realising the Potential of Global Electronic Commerce”, A Global Action Plan
for Electronic Commerce Prepared by Business With Recommendations From [sic!]
Governments,         SG/EC(98)11/REV2             (Oct.      5,     1998),       available  at
<http://www.oecd.org//dsti/sti/it/ec/prod/sgec_11e.pdf>).
18
  Involved companies include NEC Corporation, DaimlerChrysler, The Walt Disney Company,
Nortel Networks, Fujitsu Limited, EDS, Telefónica, Toshiba Corporation, and Deutsche Bank.
                                                5
                                                                                     Introduction


Working Group on Electronic Commerce as “an important new force for self-

regulation and policy leadership”19—“[c]onsumer confidence is a key issue for the

development of electronic commerce, and both business and governments have

a responsibility to foster it.”20 Retailers, finally, see lack of consumer confidence

“as their number one concern.”21


In this paper I will look at the issue of consumer confidence in greater detail. The

following section will summarize some of the characteristics and risks of distance

transactions in general and of electronic commerce over the Internet in particular.

This will help to more specifically identify possible reasons for consumers to feel

uncomfortable about engaging in commercial transactions online. It will go on to

define what “confidence”, “trust”, and similar terms actually mean, and it will

argue for making an important distinction between “trust” and “reliance.” This

distinction is not made clearly enough in the existing literature, although it has

important implications for the remedies that are suited to overcome the

confidence problem. The section will analyze the grounds of trust and reliance,

how they relate to enforcement and compliance, and why they are lacking in the

online-environment. The section wil find that above all a lack of initial trust and

reliance is likely to be a significant entry-barrier to the electronic marketplace.




19
     See W ORKING GROUP II, supra note 4, at 12.
20
  See Global Business Dialogue on Electronic Commerce (GBDe), The Paris Recommendations
(Sep. 13, 1999) (visited Aug. 17, 00) <http://www.gbd.org/conference/recommendations.html>.
21
  See Linda Leung, Five per cent of all online transactions are fraudulent , vnunet.com (Nov. 24,
1999) <http://www.vnunet.com/News/103736> (referring to a survey of 100 online retailers).

                                                   6
                                                                         Introduction


To this background part III will discuss different ways to enhance consumer

confidence. It argues that new institutions will emerge to enhance trust and

reliance, namely information intermediaries and payment intermediaries,

respectively. Of these two options, reliance mechanisms that can guarantee

cheap and effective enforcement of consumer rights ultimately appear to be the

more efficient approach to overcome the existing lack of consumer confidence. It

will emphasize the crucial role of payment intermediaries and it will in particular

discuss the introduction of a comprehensive chargeback regime as a means to

accelerate the development of business-to-consumer electronic commerce.

Part IV will summarize the findings and offer some concluding remarks.




                                        7
                      The Online-Marketplace: Shaking the Foundations of Consumer Confidence




II.      THE            ONLINE-MARKETPLACE:                            SHAKING                THE

         FOUNDATIONS OF CONSUMER CONFIDENCE

People have been engaging in business transactions for a long time. Never

before, however, have concerns about consumer confidence been subject to so

much discussion.22 In fact, every transaction requires some degree of confidence

or trust.23 So why is it that everybody seems to be particularly concerned about

consumer confidence in the electronic marketplace? The reason for this is not, as

I will lay out in more detail below, that electronic commerce requires more

consumer confidence than other types of commercial transactions. It is rather

that with regard to “traditional” transactions there have, over time, evolved some

solid bases for consumer confidence. These bases, however, appear not to work

very well with regard to online transactions. This part will analyze why.




22
   To be sure, as Cynthia Hardy et al., Distinguishing Trust and Power in Interorganizational
Relations: Forms and Façades of Trust, in TRUST W ITHIN AND BETWEEN ORGANIZATIONS 64, 66
(Christel Lane & Reinhard Bachmann eds., 1998) point out, “the literature on trust is burgeoning
and the topic has been considered by economists, psychologists, and sociologists, as well as
management theorists.” (Citations omitted). See generally infra note 149. But the emphasis on
the need to foster consumer confidence in regard to online transactions puts a new twist on the
discussion.
23
    See, e.g., John Humphrey, Trust and the Transformation of Supplier Relations in Indian
Industry, in TRUST W ITHIN AND BETWEEN ORGANIZATIONS, supra note 22, at 214, 217 (arguing
generally that “[t]he question of trust arises from the element of risk in economic transactions.”);
Partha Dasgupta, Trust as a Commodity, in TRUST: MAKING AND BREAKING COOPERATIVE
RELATIONS 49 (Diego Gambetta ed., 1988) [hereinafter TRUST (Gambetta ed.)] (“Trust is central to
all transactions ....”).

                                                 8
                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


A.          Some Characteristics and Risks of Distance Transactions

Online transactions, just like catalogue sales, mail orders, or telephone orders,

are distance transactions.24 All of these transactions share some common

characteristics.25 First, these transactions are non face-to-face transactions.26

The parties therefore will often have no knowledge of the other’s identity, age, or

whereabouts. They do not get a personal impression nor can they assess

gestures or body language.27 Moreover, they might confront information

deficiencies.28 Since it is not possible to ask a salesperson at a physical place,



24
   Consequently all of the mentioned transactions fall within the scope of the Directive 97/7/EC of
the European Parliament and of the Council on the Protection of Consumers in Respect of
Distance Contracts, 1997 O.J. (L 144) 19 [hereinafter Distance Contracts Directive]. According to
art. 2(1) of the Directive, a distance contract basically consists of two elements: (1) the exclusive
use of a means of distance communication before and for the formation of the contract and (2) an
organized distance sales or service-provision scheme run by the supplier. A means of distance
communication is defined in art. 2(4) as any means that is used for the conclusion of contracts
between parties who are not simultaneously physically present at the same location. Annex I of
the Directive contains a non-exhaustive list of such means, including printed matters, letters,
catalogues, telephone, radio, electronic mail, fax, or television. The Directive thus applies to
classic forms of distance selling such as catalogue sales, mail-order, telephone-order, or
teleshopping, as well as to more recent developments, in particular e-commerce transactions
over the Internet. See Rufus Pichler, The Directive 97/7/EC of the European Parliament and of
the Council on the Protection of Consumers in Respect of Distance Contracts: Theoretical and
Practical Impacts on Transatlantic Electronic Commerce II.B.1) (Dec. 22, 1999) (unpublished
manuscript) (on file with author and the Stanford Program in International Legal Studies).
25
  In some very important respects, however, online transactions are also distinct from the others.
See detailed discussion infra II.C.
26
  See also Froomkin, supra note 3, at 68 passim (comparing differences between face-to-face
sales, telephone sales, and Internet sales).
27
     See also infra note 190 and accompanying text.
28
   See Australian Competition & Consumer Commission, The Global Enforcement Challenge:
Enforcement of consumer protection laws in a global marketplace Part II.2., at 7-10 (Aug. 1997)
[hereinafter      ACCC,        Enforcement        Challenge],       available     online     at
<http://www.accc.gov.au/docs/global/front.htm>. It is also one of the main objectives of the
European Distance Contracts Directive to ensure sufficient consumer information, see Distance
Contracts Directive, supra note 24, recitals para 11. See also the preceding Commission
Recommendation 92/295/EEC of 7 April 1992 on Codes of Practice for the Protection of
Consumers in Respect of Contracts Negotiated at a Distance (Distance Selling), 1992 O.J. (L
156) 21, which points out the necessity of sufficient consumer information and recommends
suppliers to adopt a code of conduct with regard do distance sales.

                                                 9
                     The Online-Marketplace: Shaking the Foundations of Consumer Confidence


the nature of a distant transaction might lead to insufficient information about the

product, service, merchant, conditions of the contract, or other relevant factors.

The consumer will generally not have an opportunity to see, examine, or test the

product or to ascertain the service she is about to purchase before concluding

the respective contract.29 Nor will she get an impression of the merchant’s shop

or a feeling of comfort in regard to visible assets that might eventually allow

recourse should things go wrong.30 A second characteristic, much more of

Internet    transactions      than     of   traditional     remote     business-to-consumer

transactions like catalogue sales, mail or telephone orders, is that they are often

international—the merchant’s principal place of business being in one, the

consumer’s domicile in another country (so called cross-border transactions).31

Third, and most importantly, distance transactions are characterized by the fact,

that one party will typically have to perform prior to the other. An immediate on

the spot exchange of product or service and money, as, for example, in a




29
   See Helmut Köhler, Die Rechte des Verbrauchers beim Teleshopping (TV-Shopping, Internet-
Shopping), 1998 NEUE JURISTISCHE W OCHENSCHRIFT [NJW] 185, 186 (listing these and other risks
related to distance shopping).
30
  See Froomkin, supra note 3, at 71. We will come back to this very important point when we talk
about investment as a basis for trust, see infra II.D.3).
31
   See, e.g., ACCC, Enforcement Challenge, supra note 28, at 1; See John Rothchild, Protecting
the Digital Consumer: The Limits of Cyberspace Utopianism, 74 IND. L.J. 893, 912 (1999) (finding
an increased volume of cross-border transactions). The fact that businesses selling online have
immediate access to international markets without facing typical “offline-barriers” such as setting
up a local marketing and distribution network is repeatedly emphasized as one of the major
advantages of e-commerce. See, e.g., Fred M. Greguras et al., Software Marketing, Licensing
and Distribution in Cyberspace, 1 CYBERSPACE LAW. 4 (1996) (“The Internet provides software
vendors with wide exposure, an inexpensive marketing channel, and access to international
markets earlier than ever before.”); OECD, Measuring Trade in Software, supra note 6, at 18-22
(giving estimates for international trade in digital products over the Internet).

                                                10
                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


physical store,32 is impossible. This last characteristic makes the transaction

risky, particularly for the party that has to perform in advance. She might fulfill her

obligation just to learn later that the other party does not fulfill hers in return.33

This risk of prior performance will be an important background to most of the rest

of this paper.


In the broader context of possible barriers to the full development of e-

commerce, however, it is important to note that the fear of fraud is only one of a

variety of factors that can potentially impair the growth of e-commerce.34 These

factors include35 economic, factual, and technological barriers, mainly the ease

and cost of access to the Net,36 the availability of broad band connections,37 and

of course the accessibility of the merchants’ servers38 as well as a satisfactory




32
  See also Froomkin, supra note 3, at 70 (stating that “in a face-to-face sale, there is no problem
with moving value”).
33
   Louis H. Bluhm, Trust, Terrorism, and Technology, 6 J. BUS. ETHICS 333, 338 (1987) expresses
this words that are much more sophisticated: “In the marketplace, where the self-interest of one
actor is likely to be advanced at the expense of another, there is an inherent fear that others will
succumb to the temptation to misrepresent behavior and use deception in the exchange process.”
34
  Besides the fact that ultimately consumers actually need to have an interest in the goods or
services offered, which is, of course, by no means unique to e-commerce.
35
   See also United States Government, Electronic Commerce Policy, Request for Public
Comment on Legal Barriers to Electronic Commerce (visited Aug. 17, 00)
<http://osecnt13.osec.doc.gov/ecommerce/barriers.nsf>.
36
     See, e.g., OECD, THE IMPACT OF ELECTRONIC COMMERCE, supra note 2, at 42.
37
   See DIGITAL ECONOMY II, supra note 4, at 7; W ORKING GROUP II, supra note 4, at 3-17
(emphasizing the importance of high speed Internet access and summarizing the progress with
regard to the respective presidential Directive).
38
  A study by Andersen Consulting found that 25 percent of attempted online purchases failed
because the merchants’ web sites could not take orders because they crashed, were blocked,
were under construction, or were otherwise inaccessible. See Andersen Consulting, Press
Release, One Quarter of Attempted On-Line Holiday Purchases End in “No Sale” (Dec. 20, 1999)
<http://www.andersen.com/news/newsarchive/12.99/newsarchive_122099.html>.

                                                11
                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


handling of orders.39 Whether they are charged at a flat rate or face a metered

pricing structure for local phone calls or a flat or metered fee for Internet access

through their Internet Service Provider (ISP) makes a difference with regard to

how much time users spend online.40 And the time users spend online, as does

the available bandwidth which is responsible for download times41 and

contributes to the overall convenience of the “shopping experience”,42 relates

directly to how much money they spend online.43 Besides ease and cost of

access, speed of transmission, and convenience sources frequently list

psychological factors such as users’ preference for the experience of buying

products that they can see, feel, or try on in person44 among possible factors

slowing down the development of e-commerce. On the other hand, all these

factors and a fear of consumer fraud45 can obviously also deter merchants from

selling online.


Neither a limited infrastructure nor individual preferences, however, but concerns

seem to be the predominant inhibitor that accounts for a continuing wariness of a




39
   See infra note 123 (pointing to consumer’s fears that their online holiday purchases will not
arrive in time).
40
     See sources cited supra note 37.
41
  For a comparison of download times using different technologies see DIGITAL ECONOMY I, supra
note 4, at 9.
42
   See id. See also OECD, THE IMPACT OF ELECTRONIC COMMERCE, supra note 2, at 42
(particularly pointing to the importance of convenience to users).
43
   See id. (referring to an ActivMedia study for “[t]he finding that the longer shoppers use the
Internet, the more likely they are to buy on line ....”). See also Nie & Erbring, supra note 1, at 5.
44
  See DIGITAL ECONOMY I, supra note 4, at 45. See also OECD, Measuring Trade in Software,
supra note 6, at 45 (“consumers’ love for the ‘look and feel’ of the software box, ....”).
45
     As opposed to merchant fraud, see infra II.A.1).

                                                  12
                     The Online-Marketplace: Shaking the Foundations of Consumer Confidence


significant number of users to shop online. The top three concerns are privacy,

security, and fraud.46 Privacy, about which according to a 1998 poll 81 percent of

American Internet users have significant concerns,47 touches on many of the

issues that will be discussed here. Particularly the question of trust is frequently

addressed in regard to what users believe a merchant will or will not do with their

personal data and how that influences their decision as to whether or not to

transact with a particular merchant.48 The scope of this paper, however, does not

allow to discuss the problem of privacy further,49 since it raises a whole set of

different and complex issues. Instead I will focus on the two other main concerns:

security and fraud.


1)       Security and Consumer Fraud
Security concerns, to the extent they are of interest here, are really just concerns

about an anticipated fraud. Fraud can basically occur in two forms: It can be

committed against the merchant, which I will call consumer fraud, or it can be




46
   See, e.g., OECD, THE IMPACT OF ELECTRONIC COMMERCE, supra note 2, at 42; DIGITAL ECONOMY
I, supra note 4, at 45; DIGITAL ECONOMY II, supra note 4, at 7; W ORKING GROUP II, supra note 4, at
iv; FRAMEWORK, supra note 15, at 11, 14, 19 (each listing some or all of these concerns among
the barriers for e-commerce growth). See also Michael Lee et al., Electronic Commerce, Hackers,
and the Search for Legitimacy: A Regulatory Proposal, 14 BERKELEY TECH. L.J. 839, 841-42
(1999) (“[M]any consumers continue to have little confidence in the ability of sellers to deliver
goods and services without compromising the security of sensitive information.”).
47
  See W ORKING GROUP I, supra note 4, at 16. The awareness and the concerns about privacy
seem to have been rising constantly before and since then, see, e.g., Roland Vogl, The EU—U.S.
Privacy Debate (May 2000) (unpublished manuscript) (on file with author and the Stanford
Program in International Legal Studies) and the sources cited there.
48
  Note, however, that not all of the solutions discussed and proposed herein are applicable to the
privacy problem.
49
  For a thorough and recent discussion of privacy issues in cyberspace see Symposium,
Cyberspace and Privacy—A New Legal Paradigm, 52 STAN. L. REV. (forthcoming 2000).

                                                13
                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


committed against the consumer, which I will consequently refer to as merchant

fraud.50 Concerns about the security of network communications or the network

infrastructure, mainly about third parties getting access to data that they are not

supposed to get access to, typically just anticipate a third type of fraud at a later

stage—third party fraud. This is quite obvious if one agrees with the basic

assumption that merely getting access to secret data normally51 is not the

ultimate end of the intruder’s conduct. Typically she wants to use this data to his

own advantage, i.e. committing fraud against a merchant, a consumer or some

other institution such as a bank or credit card company. Who exactly the ultimate

victim of third party fraud will be, depends on the legal risk allocation among the

parties that are involved. In the case of an unauthorized use of a credit card, for

example, the victim could be the card issuer, the merchant who accepts the card

for payment, or the cardholder, depending on how the parties and the law

allocate this risk under the given circumstances.52




50
   See infra II.A.2). Note that the use of the terminology varies. Consumer fraud and merchant
fraud means the opposite when one does not use it for fraud by consumers or merchants (as it is
used here), but for fraud committed against consumers or merchants (as it is used, for example,
in Federal Trade Commission, Report, Fighting Consumer Fraud: New Tools of the Trade (April
1998) <http://www.ftc.gov/reports/fraud97/fraud97.pdf> [hereinafter FTC, New Tools of the Trade]
or in Federal Trade Commission, Report, Fighting Consumer Fraud: The Challenge and the
Campaign (Jan. 1997) <http://www.ftc.gov/reports/Fraud/index.htm> [hereinafter FTC, The
Challenge and the Campaign].
51
  I will leave aside the phenomenon of the honorable hacker, whose only goal it is to find security
leaks in the system and who doesn’t pursue any self-interest. I will leave this phenomenon aside
for two reasons: First, because I believe these people to be an endangered species, and more
importantly, because of the fact that when people do have concerns about security they will
normally think about those, who will actually misuse the data they discovered. For an overview on
hackers and their various activities see generally Lee et al., supra note 46.
52
     See infra text accompanying notes 59 passim.

                                                14
                      The Online-Marketplace: Shaking the Foundations of Consumer Confidence


The credit card example was not chosen arbitrarily. In fact, concerns about the

security of payments or credit card information are among those most frequently

expressed by consumers.53 This example clarifies that security concerns, in

general, are actually concerns about anticipated fraud at a later stage. Shortly

before Christmas 1999, in a case that draw extensive media attention,54 a

hacker, “Maxus”, claimed that he got access to about 300.000 credit card

numbers from customers of online music retailer CD Universe.55 In fact, he made

as many as 25.000 numbers available on a web page after the company refused

to pay $100.000. The attempted extortion56 tried to take advantage of the fear of

a subsequent fraudulent use of these numbers. It actually was confirmed that

some of the numbers have been used for fraudulent online purchases and the

hacker alleged that he had already sold 10.000 of them before the website was

eventually shut down.57 Thus, the security concerns, at least with regard to online



53
  See, e.g., OECD, THE IMPACT OF ELECTRONIC COMMERCE, supra note 2, at 42 (security of
payments); DIGITAL ECONOMY I, supra note 4, at 45 (security of credit card information); DIGITAL
ECONOMY II, supra note 4, at 7 (security of credit card purchases). From a legal point of view,
however, this concern, if expressed by consumers (i.e. cardholders) is hardly rational, see infra
note 77.
54
  See, e.g., Will Knight, Every e-commerce site’s nightmare as hacker gets nasty with credit card
details, ZDNet UK (Jan. 12, 2000) <http://www.zdnet.co.uk/news/2000/1/ns-12576.html>; Mike
Brunker, Data thief threatens to strike again, ZDNet UK (Jan. 12, 2000)
<http://www.zdnet.co.uk/news/2000/1/ns-12574.html>; ZDNet, Like stealing credit cards from
babies, ZDNet UK (Jan. 13, 2000) <http://www.zdnet.co.uk/news/2000/1/ns-12608.html>. See
also Bob Sullivan, How to steal 2,500 credit cards , ZDNet UK (Jan. 17, 2000)
<http://www.zdnet.co.uk/news/2000/2/ns-12672.html> (
55
     See <http://www.cduniverse.com>.
56
   See generally, Tom Steinert-Threlkeld, It’s a new era—of economic blackmail , ZDNet News
(Feb. 9, 2000) <http://www.zdnet.com/zdnn/stories/comment/0,5859,2435665,00.html> (referring
to an attack in early Feb. 2000 that took down some of the biggest e-commerce sites, including
Yahoo, E*Trade, Buy.com, ZDNet, for several hours as setting the stage for a new type of
economic blackmail).
57
 See also Randy Gainer, Allocating the Risk of Loss for Bank Card Fraud on the Internet, 15 J.
MARSHALL J. COMPUTER & INFO. L. 39, 42-44 (1996) (giving similar examples of posting, trading
                                            15
                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


payment mechanisms, are ultimately concerns about fraud. Note that the victims

in these cases58 will typically be the merchants, not the consumers. The legal

situation both in the U.S. and in Europe is straightforward in this respect and

clearly suggests that it is the merchants that should be worried about the security

of online payment systems because in general they will have to bear the risk of

loss in these cases.


In the U.S. the use of credit cards is mainly regulated by the Truth-in-Lending Act

(TILA)59 and the Federal Reserve Board’s implementing Regulation Z.60 In the

event of an unauthorized use of the credit card (in the online context basically the

use of the card data by a third party) the liability of the cardholder is generally

limited to a flat $50.61 One condition for imposing liability on the cardholder at all,

however, is that the card issuer has provided a means to identify the cardholder,

such as a signature, photograph, or fingerprint on the card.62 In transactions that

do not physically involve the card, such as mail order/telephone order and online

transactions, this condition is not met, “[s]ince the issuer has not provided a




and selling credit card numbers online that have been stolen while transmitted over the network
or from merchants that have neglected server security).
58
  As in the majority of cases if it is true that “the most common types of [fraudulent] activity [are]
the use stolen credit cards, false identities and card generators”, see Leung, supra note 21.
59
  Title I of the CONSUMER CREDIT PROTECTION ACT (CCPA) of 1968, 15 U.S.C §§ 1601-1667f.
See generally RALPH C. CLONTZ, JR., TRUTH-IN-LENDING MANUAL (Update No. 3, 1997).
60
     12 C.F.R part 226 (1999).
61
     See id. § 226.12(b).
62
   See id. § 226.12(b)(2)(iii) and Official Staff Interpretations, 12 CFR 226, Supp. I § 12(b)(2)(iii),
at 1. (1999).

                                                  16
                          The Online-Marketplace: Shaking the Foundations of Consumer Confidence


means to identify the user under these circumstances, ....”.63 Therefore, in the

event of an unauthorized use of her credit card data in Internet transactions, a

cardholder is not liable at all—not even for $50.64. Merchants and card issuers

are seldom as clear in this respect as Sean Healy, a spokesman for VISA USA,

who, referring to the CD Universe case,65 was cited having said that in most

cases there will be “no consumer liability”.66 And while the consumer is basically

out of it, the contractual agreements between card issuer and merchant typically

shift the risk of an unauthorized use that occurs without the physical presentation

of the card and absent a sales slip signed by the card user to the merchant by

allowing the card issuer to charge the transaction back to him.67


European law leads to the same result. Art. 8 of the European Distance

Contracts Directive68 deals with payment by card in such contracts. It obligates

Member States to give consumers the right (that in fact already exists in most of

the Member States)69 “to request cancellation of a payment where fraudulent use




63
   See Official Staff Interpretations, supra note 62, § 12(b)(2)(iii), at 3. (emphasis added). See
also Jane Kaufman Winn, Clash of the Titans: Regulating the Competition Between Established
and Emerging Electronic Payment Systems, 14 BERKELEY TECH. L.J. 675, 687 (1999).
64
   Thus, with regard to online transactions Gainer, supra note 57, at 45 (1996) is incorrect when
he states that “[w]hile the statute allows card issuers to impose liability up to fifty dollars, this is
rarely attempted by lenders; ....” Because of Reg. Z, supra note 60, § 226.12(b)(2)(iii), which
Gainer does not mention, the issuer could not even impose that liability. Froomkin, supra note 3,
at 71 n.70 is similarly unclear on that point.
65
     See supra note 55 and accompanying text.
66
     See Brunker, supra note 54.
67
  See Kaufman Winn, supra note 63, at 687; LARY LAWRENCE, AN INTRODUCTION TO PAYMENT
SYSTEMS 515-16 (1997).
68
     See supra note 24.
69
  See Bundesministerium der Justiz, Referat I B 2, Referentenentwurf Fernabsatzgesetz 44
passim [Draft of a German Distance Contracts Act], Doc. 3420/12-4 (May 31, 1999)
                                           17
                          The Online-Marketplace: Shaking the Foundations of Consumer Confidence


has been made of his payment card in connection with distance contracts

covered by this Directive” and “in the event of fraudulent use, to be recredited

with the sums paid or have them returned.” Thus, in the event of an unauthorized

use of the credit card data the card issuer can only impose any liability on the

cardholder when the latter acted negligently (e.g. when she left her card

somewhere and it is stolen and then misused).70 However, the transmission of

credit card data over the Internet, even over insecure channels, is not regarded

as constituting a negligent act by the cardholder.71 Consequently, as in the U.S.,

the European cardholder is generally72 not liable for an unauthorized use of her

card data on the Internet. And as in the U.S., the contractual agreements

between card issuer and merchant ultimately shift the risk to the latter.73


It becomes apparent, that the fact that security attacks of this kind—particularly

worries about the security of credit card data—rank among consumers’ most

frequently expressed concerns is mostly74 due to a common misconception of the




<http://www.bmj.bund.de/download/fernag.pdf> [hereinafter BMJ, Draft Distance Contracts Act]
(citing Rufus Pichler, Kreditkartenzahlung im Internet, 1998 NEUE JURISTISCHE W OCHENSCHRIFT
[NJW] 3234).
70
    Although there is—in these cases of negligent conduct by the cardholder—no legal
requirement to limit the cardholders liability (unlike under U.S. law, see supra note 61), all card
issuers follow a recommendation by the European Commission (see Commission
Recommendation of 17 November 1988 concerning payment systems, and in particular the
relationship between cardholder and card issuer (88/590/EEC), 1988 O.J. (L 317) 55, Annex 8.3,
available online at <http://www.europa.eu.int/eur-lex/en/lif/dat/1988/en_388X0590.html>) and limit
it to a flat $50 as well. See RUFUS PICHLER, RECHTSNATUR, RECHTSBEZIEHUNGEN UND
ZIVILRECHTLICHE HAFTUNG BEIM ELEKTRONISCHEN ZAHLUNGSVERKEHR IM INTERNET 74 (1998).
71
     See Pichler, supra note 69, at 3236 and the sources cited therein.
72
     This can change with the use of secure payment systems such as SET, see infra note 85.
73
     See Pichler, supra note 69, at 3237.
74
     See infra note 77.

                                                  18
                     The Online-Marketplace: Shaking the Foundations of Consumer Confidence


legal risk allocation in cases of unauthorized use of credit card data.75 The fact

that these worries nevertheless seem to be such an important inhibitor of

consumer confidence is probably the result of widespread confusion and a lack

of education in regard to the “real” risks. A report by Jupiter Communications

finds that great media attention fuels consumer fears and that online businesses

must better educate consumers.76 But when going on that “[c]onsumers have

confused the concepts of privacy and security; they identify security of credit card

information, which is their primary concern, as a privacy issue”, even that report

misses the issue in which education seems to be needed most—i. e. that, from

the consumer’s point of view, the concerns about the security of credit card

information are irrationally exaggerated.77




75
   See also Gainer, supra note 57, at 48 (concluding that “[c]onsumers should not be concerned
about potential theft of their bank card data, because federal statutes generally prevent the
consumer from incurring liability for any significant misuse of the card data.”); Kaufman Winn,
supra note 63, at 687 (finding that the high level of consumer protection regarding credit card
transactions “minimize the transaction risks assumed by consumers in Internet transactions by
shifting the risks back onto the merchant, the merchant’s bank or the card issuer.”); Froomkin,
supra note 3, at 76 (“the risk may be smaller than commonly believed”).
76
  See Jupiter Communications, Press Release, 64 Percent of Online Consumers are Unlikely to
Trust           a           Web            Site           (Aug.             17,          1999)
<http://www.jup.com/company/pressrelease.jsp?doc=pr990817>. See also Jane Wakefield,
Media     blamed    for   consumer    online    fears ,  ZDNet     UK      (Aug.  18,    1999)
<http://www.zdnet.co.uk/news/1999/32/ns-9370.html> (referring to the aforementioned report);
Jane Wakefield, Online fraud warning to all e-commerce users, ZDNet UK (Feb. 1, 2000)
<http://www.zdnet.co.uk/news/2000/4/ns-13032.html> (citing the director of a company that tests
networks who warned consumers using the Net for e-commerce: “Be afraid, be very afraid.”).
77
   It is true, however, that consumers might face considerable inconveniences. They will have to
check their balance statements for unauthorized charges regularly, they might need to invest time
to initiate being recredited with the amount charged, they might find it embarrassing to face and
contest charges for allegedly using adult entertainment services and so on. Thus, their concerns
are certainly not completely irrational. For an example of one concern see The growing threat of
internet           fraud,           BBC          News           (Nov.          19,           1999)
<http://news.bbc.co.uk/hi/english/business/your_money/newsid_526000/526709.stm>           (“Credit-
card numbers obtained by theft of from anarchist websites on the Internet are used to access
pornographic net pages, and innocent people are charged.”).

                                                19
                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


The merchants, however, who one would expect to really be concerned because

they have to bear the loss of online credit card fraud, do not appear to be too

worried about security.78 And there might be good reasons why they—despite all

the fuzz—in fact need not be (and even better reasons, why we need not worry

too much about online merchants becoming victims of credit card fraud either).

First, the degree of credit card fraud actually does not seem to be so high after

all. Although it is alleged that half of all credit-card disputes concern Internet

transactions,79 “credit card fraud [in general] is at a historical low point (between

7 and 8 cents per $100)”,80 according to Spencer Nilson, whose Nilson Report81

has been the leading publication on consumer payment systems worldwide for

thirty years. It appears that merchants can afford to accept the costs of fraud with

regard to increasing returns from a much larger volume of regular transactions.82

Second, it is in the merchant’s own hand to increase the security.83 And indeed

there are various systems that aim to make electronic transactions and online

payments more secure—for merchants. The widespread use of certified digital




78
  See Sullivan, supra note 54, for an account of how surprisingly shoddy security of some e-
commerce sites facilitates the theft of credit card data.
79
   According to information by VISA International, see Fraud continues to deter e-shoppers, IT-
Analysis.com (Nov. 22, 1999) <http://www.it-analysis.com/99-11-22-2.html>; The growing threat
of internet fraud, supra note 77.
80
     See Brunker, supra note 54 (citing Nilson).
81
     See <http://www.nilsonreport.com>.
82
     See Kaufman Winn, supra note 63, at 688.
83
  And from an economic point of view one would expect them to do so as long as the costs of
enhancing security are lower than the costs of fraud. To this background there will always be
some fraud which to prevent would be inefficient. See also Brunker, supra note 54 (citing Nilson
making a similar point).

                                                   20
                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


signatures84 and their implementation in secure electronic payment systems such

as SET85 would allow merchants to significantly reduce the risk of consumer

fraud.86 Digital signatures are based on public key encryption.87 This means a

party possesses a unique pair of keys. One is the private key that is secret,

under the party’s sole control (its use is normally protected by a password known

only to that party), and secure (meaning the key can in practice not be forged).

The other is a public key that can be freely distributed and is often stored in

publicly accessible databases. To make sure to whom a certain public key

belongs, a certification authority (CA) is involved.88 The CA verifies the identity of

the user of a key pair and attaches a certificate (that again cannot be forged) with

information on the holder of the corresponding private key to the public key.



84
   For a recent and comprehensive overview on the technology of digital signatures and the
related legal issues see Symposium, Digital Signature and Electronic Document Verification, 17
J. MARSHALL J. COMPUTER & INFO. L. 721 (1999).
85
   For a description of the system see SET Secure Electronic Transactions LLC, What is SET
(visited Aug. 17, 00) <http://www.setco.org/set.html>; VISA, Internet Shopping: SET (visited Aug.
17, 00) <http://www.visa.com/nt/ecomm/security/set.html>; MasterCard, Shop Online: SET
(visited Aug. 17, 00) <http://www.mastercard.com/shoponline/set>. For a legal perspective see
Pichler, supra note 69, at 3237 passim; Kaufman Winn, supra note 63, at 689-691.
86
   It has also been argued that it would allow consumers to reduce merchant fraud as well (see
Kaufman Winn, supra note 63, at 691 (“SET was marketed as a solution to the problem of
consumer fraud through false claims of unauthorized use of a card as well as to the problem of
merchant fraud.”). Although it is true that certified digital signatures would tell the consumer with
whom she is dealing, her more important problem would remain unsolved: The consumer would
still not have a means to effectively and efficiently enforce her rights (e.g. her claim for a refund of
the amount paid) against the merchant. For a detailed discussion of this problem see infra II.C.1).
87
   I will just very briefly sketch the functionality of digital signatures here. For a more detailed
description see, for example, David L. Gripman, Electronic Document Verification: A Primer on
the Technology Behind Digital Signatures, 17 J. MARSHALL J. COMPUTER & INFO. L. 769 (1999).
See also Rufus Pichler, Richtlinienvorschlag zu elektronischen Signaturen, 1998 EUROPEAN LAW
REPORTER 523, 524. For an easy-to-understand explanation of public key encryption and digital
signatures see also STEWART A. BAKER & PAUL R. HURST, THE LIMITS OF TRUST 1-2 (1998);
Froomkin, supra note 3, at 51-67.
88
  See generally Froomkin, supra note 3, at 55-67 (explaining the role and various functions of
CA’s).

                                                  21
                     The Online-Marketplace: Shaking the Foundations of Consumer Confidence


Although the keys belong together and the public key is needed and used to

verify a message “signed” with the private key, it is not possible to derive the

private key from the public key. A message is signed89 with the signatory’s

private key. The recipient then uses the signatory’s public key (which is sent with

the message or retrieved from a database and includes the certificate) to verify

the signature.90


To clarify things, note the key characteristics of digital signatures as they are

listed in the recent EU Directive on Electronic Signatures:91 It is (a) uniquely

linked to the signatory, (b) capable of identifying the signatory, (c) created using

means that the signatory can maintain under his sole control, and (d) linked to

the data to which it relates that any subsequent change of the date is detectable.

From the perspective of the recipient the consequences are the following: She

knows (a) that the message she received can come from only one person (i.e.

the possessor of the private key), since the key is unique, (b) who the signatory

is, (c) that no one other than the signatory has access to the key without the

signatory’s consent or negligence, and (d) that the signatory has actually sent




89
  Signing means that a program creates a hash or message digest of the message, which
uniquely identifies this message and is, if created anew, always the same unless the message
has been altered. This hash is encrypted with the signatory’s private key and then sent with the
message.
90
  In fact she uses the public key to decipher the hash and compare it to the hash her program
created of the message that has been signed. If the two functions are the same, she knows that
the message she received has not been altered.
91
  See Directive 1999/93/EC of the European Parliament and of the Council of 13 December 1999
on a Community framework for electronic signatures, 2000 O.J. (L 13) 12, art. 2(2). See generally
Rufus Pichler, Signaturrichtlinie, 2000 EUROPEAN LAW REPORTER 75 (giving an overview on and
analyzing the Directive).

                                               22
                      The Online-Marketplace: Shaking the Foundations of Consumer Confidence


exactly the message received (i.e. that there has been no forgery in the course of

the transmission).


Thus, when integrated into payment systems, digital signatures can effectively

take care of merchants’ security concerns and practically eliminate consumer

fraud. Consequently one need not worry too much about merchants becoming

victims of consumer fraud, because if the problem would really get out of hand,

one can expect to quickly see a more widespread implementation of systems like

SET.92


What raises a little more concern, however, is the opposite scenario: consumers

becoming the victims of merchant fraud.


2)       Merchant Fraud and Consumer Redress
As a matter of fact, it typically is the consumer who bears the risk of prior

performance that is inherent to remote transactions. In general, merchants will

require some kind of advance payment before sending goods to a consumer or

granting her access to information or other services.93 In most online transactions



92
   To date a broad implementation cannot be observed, however. This is partly due to the fact
that SET not only very secure, but also “complex and cumbersome” (see Kaufman Winn, supra
note 63, at 690), and probably mostly to the fact that in regard to the relation between returns and
the total volume of chargebacks merchants have not seen the economic benefits, let alone
necessity, to switch to a more secure system. See also id. at 697 (describing why so far
everybody with the status quo relying on SSL which does not use digital signatures and basically
only provides for security of the data during the process of transmission; it does not, however,
prevent consumer fraud).
93
   See, e.g., ACCC, Enforcement Challenge, supra note 28, at 11 (“payment for goods and
services in the global marketplace is often made in advance”); Frank Diedrich, Internationales
Einheitsrecht—Internationalisierung   der   Rechtswissenschaft?,   in   JAHRBUCH      JUNGER
ZIVILRECHTSWISSENSCHAFTLER 1998: VERNETZTE W ELT—GLOBALES RECHT 45, 65 (Martin
Immenhauser & Jürg Wichtermann eds., 1999) (emphasizing the practice of advance payment).
                                             23
                     The Online-Marketplace: Shaking the Foundations of Consumer Confidence


that “payment” will consist of an authorization to charge the consumer’s credit

card,94 although there exist a variety of alternative electronic payment systems.95

Almost all non-cash forms of payment aim at creating a high degree of finality96

by making it hard if not impossible for the payer to simply reverse the payment

once she authorized it.97 A higher degree of finality reduces the merchants’ risk98

and at the same time assigns the risk of prior performance to the consumer, who

will eventually have to take action to make the merchant repay the amount if she



See also Consumers International, Consumers@shopping: An international comparative study of
electronic              commerce                   35                  (Sept.              1999)
<http://www.consumersinternational.org/campaigns/electronic/e-comm.pdf> (finding that “[i]n 71%
of cases researchers had to pay for goods before they arrived, ....”).
94
  Credit cards are by far the prevailing payment method in business-to-consumer e-commerce.
See Kaufman Winn, supra note 63, at 687 (speaking of the “current dominance of credit cards as
the payment device of choice for retail Internet services.”); John D. Muller, Selected
Developments in the Law of Cyberspace Payments, 54 BUS. LAW . 403 (1998) (“by far the
dominant form of payment for Internet transactions.”).
95
   See generally PICHLER, supra note 70; Pichler, supra note 69; Muller, supra note 94; Robert F.
Stankey, Internet Payment Systems: Legal Issues Facing Businesses, Consumers and Payment
Service Providers, 6 COMMLAW CONSPECTUS 11 (1998); Gainer, supra note 57; Kaufman Winn,
supra note 63; Dan L. Nicewander, Electronic Banking—Smart Cards, Cyberspace and the
Internet, 50 CONSUMER FIN. L.Q. REP. 22 (1996) (all discussing new electronic payments systems
for the Internet and related legal issues).
96
   Cash has an absolute finality. Once it is handed over to the merchant, the payment cannot
(legally) be reversed by an act of the payer alone. Merchants accepting alternative forms of non-
cash payment (like checks, electronic funds transfer, debit cards, credit cards etc.) have always
been longing for a comparable level of finality, since they did not want to assume the risk of the
payer reversing the payment afterwards. The specific degree of finality and the point in time at
that a payment becomes final, however, vary from payment system to payment system and from
country to country. In Germany, for example, most non-cash forms of payment have a high
degree of finality, mostly due to guarantees of payment by banks or other payment providers
(examples include the guaranteed “euro-cheque”, or credit cards under certain conditions, and
new Internet payment systems like CyberCoin or Digicash). See PICHLER, supra note 70, at 19
n.90 and accompanying text. In the U.S. the degree of finality, at least in regard to checks and
credit cards, is lower. See, e.g., Kaufman Winn, supra note 63, at 683, 686 (pointing to the low
degree of finality of checks and credit cards, respectively).
97
   See generally Kaufman Winn, supra note 63, at 679 (describing finality of payments and its
significance for payer and payee).
98
   See also Froomkin, supra note 3, at 69 (pointing out that merchants generally desire
nonrepudiation of a consumer’s order and assurance that payment will be made, which can be
achieved “by having payment before sale, at time of sale, or by provision of a payment
guarantee”).
                                            24
                         The Online-Marketplace: Shaking the Foundations of Consumer Confidence


feels it is not entitled to keep it. Thus, finality of payment in effect allocates the

burden of having to take (legal) action in the event of a dispute. It is not the

merchant who needs to bring an action against the consumer to get the money,

but it is the consumer who needs to bring an action if, for some reason, she

wants her money back. Finality of payment or the consumer’s ability to reverse

payments and thus shift the burden of taking action back to the merchant are

crucial issues in the context of effective enforcement of consumer rights and

enhancement of consumer confidence.99


Assume for now100 that the risk of prior performance, which is equivalent to the

burden of taking action to retrieve the amount paid, is typically born by the

consumer—due to the merchants’ insistence on advance payment in one form or

the other.101


To this background there are a number of scenarios, an online shopper could—

some suggest should102—be worried about.103 To begin with, consumers face a




99
     See infra note Fehler! Textmarke nicht definiert. and accompanying text.
100
      This assumption is definitely realistic with regard to European consumers. See supra note 96.
101
   See supra notes 96-98 (explaining methods of advance payment or charge or equivalent
payment guarantees).
102
      See Wakefield, supra note 76, and the citation restated there: “Be afraid, be very afraid.”
103
    See also Rothchild, supra note 31, at 903-911 (listing varieties of online deceptive marketing
practices, distinguishing fraudulent and misleading online conduct and citing DANIEL J. BARRETT,
BANDITS ON THE INFORMATION SUPERHIGHWAY 47-122 (1996) for a discussion of the varieties of
Internet-based fraud); Hebe R. Smythe, Fighting Telemarketing Scams, 17 HASTINGS COMM. &
ENT. L.J. 347, 350 passim (1994) (describing various telemarketing scams).

                                                    25
                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


variety of scams and fraudulent “merchants” on the net.104 Rothchild105 gives

numerous examples for pyramid schemes, chain letters, bogus business

opportunities, credit repair schemes, “miracle” health or diet products, investment

and securities scams, and fraudulent gambling sites.106 On legal e-mail lists107 an

increasing number of postings report cases in which adult entertainment sites

asked users for their credit card information “for age verification only” and

subsequently charged their account alleging that the user agreed to a

subscription.108 Scams like these109 presumably also profit from the fact that

victims are too embarrassed to contest the charges.110 They are obviously also

responsible for the following warning, which could be found on Citibank’s




104
    It is interesting to note that, according to a survey of 100 retailers cited by Leung, supra note
21, “41 per cent of respondents did not realise that merchants themselves were also responsible
for online fraud, however.”
105
      See supra note 103.
106
      For more examples and a short description of numerous cases see Federal Trade
Commission, Report, The FTC’s First Five Years Protecting Consumers Online 8 passim (Dec.
1999) <http://www.ftc.gov/os/1999/9912/fiveyearreport.pdf> [hereinafter FTC, First Five Years]
(listing hijacking, web cramming, pyramid schemes, credit scams, auctions, business and
investment opportunity scams, and health claims).
107
   See, e.g., Bernd Goecke, Re: Kreditkarten im Internet (Feb. 18, 2000), posted to netlaw-
l@listserv.gmd.de,       available      online    in     the      list’s    archive      at
<http://www.listserv.gmd.de/htbin/wa.exe?A2=ind0002&L=netlaw-l&F=&S=&P=23268> (reporting
a case the Goecke, a German lawyer, represented).
108
   See also FTC v. J.K. Publications, Inc., No. CV-990004 ABC (AJWx) (C.D. Cal. filed Jan. 5,
1999) (monthly charges of $19.95 for “adult Internet services” that consumers allegedly had never
ordered).
109
    The practice of billing for unauthorized services (in addition to the cases described above this
includes, for example, billing consumers after promising a “free trial period”, see FTC v. U.S.
Republic Communications, Inc., No. H-99-3657 (S.D. Texas filed Oct. 21, 1999)) is called
“cramming”, see, e.g., FTC, First Five Years, supra note 106, at 9. See also FTC v. Shared
Network Services, LLC, No. CIV. S-99-1087 WBS JFM (E.D. Cal. filed June 2, 1999); FTC v.
WebViper, LLC, 99-T-589-N (M.D. Ala. filed June 9, 1999); FTC v. Wazzu Corporation, SACV-99-
762-AHS (C.D. Cal. filed June 7, 1999) (in all cases defendants allegedly charged customers
despite offering a “free 30-day-trial”).
110
      See also supra note 77.

                                                 26
                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


German VISA billing statements: “A tip for Internet users: Your Citibank Visa

Card can also be used very well on the Internet, since it is accepted by a large

number of merchants. We recommend, however, not to transmit your card

number in regard to free offers. These may lead to subscriptions, that will result

in charges to your Visa card account.”111


While it might be argued that the examples of online scams and fraudulent

merchant behavior given above are in some way special since their mere content

should make users suspicious, there are other types of fraud that can occur in

any “everyday” transaction.


The clearest of these cases certainly is that in which the goods or services the

consumer paid for are never delivered.112 Since setting up an online “shop”—

which potentially reaches a global market—requires next to no start-up

investment and incurs very low operating costs,113 the Internet appears to

provide an almost perfect environment for scams of this kind.114 “Merchants” do



111
   Citcorp Card Operations GmbH Billing Statement to the author (Oct. 22, 1999) (on file with
author) (translation by author).
112
  See Rothchild, supra note 31, at 906 (citing a number of FTC decisions); ACCC, Enforcement
Challenge, at 11.
113
    See Carey Heckman, Gateways to the Gobal Market: Consumers and Electronic Commerce
at 1.2 (visited Aug. 17, 00) <http://www-techlaw.stanford.edu/pages/OECDBack.html> (“All
enterprises, including the small and medium-sized, can reach customers throughout the world
instantly and comparatively inexpensively.”).
114
    See ACCC, Enforcement Challenge, supra note 28, at 15 (listing a number of features that
make the Internet “an attractive means of operation for unethical traders”, including easy entry,
access to consumers worldwide promising high turnovers, anonymity and the ease of escaping
detection, the transitory nature of the business which allows to close up operations and set up
new schemes in different countries quite easily); FTC, First Five Years, supra note 106, at 3 (“It
[the online marketplace] is just as attractive to the fraudster as it is to the legitimate business. It is
cheap and easy to enter, and it enables a worldwide reach. It offers anonymity and easy exit,
often before authorities have the chance to detect wrongdoing.”); FTC, New Tools of the Trade,
                                                   27
                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


not need to rent a physical store; they do not need to display any items and must

not be personally present. They can simply design a website offering various

products or services that they do not actually have or can provide and, of course,

never intend to deliver. Before people realize that they became victims of a

scam, the “shop” (i.e. the website) might already have closed down and

“reopened” under a different name and design, targeting different users.115 The

identity and the actual physical location of the people behind it will generally be

very hard to track.


Quite similar to opening a website and selling products or services with the intent

not to perform after the consumer’s payment has been received is “spoofing”.116

Here the fraudster doesn’t set up her own online shop, but assumes the identity

of a well known company and accepts orders and payments for products or

services actually sold by that company.117 Neither orders nor payments, of

course, ever reach that company—just as the services or products purchased

never reach the consumer. Other types of merchant fraud include misleading or




supra note 50, at 3 (“Con artists also are online, hoping to take advantage of low startup costs;
the possibility of ‘real-time’ immediate payments; a nearly infinite number of places to ‘hide’ from
law enforcement; unparalleled ability to mimic legitimate business; and instant access to a global
customer base. Today’s fraud peddlers can confuse consumers more easily through web sites
that are as sophisticated and appealing as those of many legitimate businesses.”).
115
   For similar scam schemes in the telemarketing world see Smythe, supra note 103, at 351
(“Before the victims discover the fraud, the yak unplugs the telephones and moves to another
location to begin a new scam.”). Moving to another “location” is obviously much easier online.
116
      See, e.g., Rothchild, supra note 31, at 908 (describing spoofing).
117
    See also FTC, New Tools of the Trade, at 16 (describing cases of deceptive URL’s, including
http://www.internic.com, the site of an Australian company that designed a look-alike site to
Network Solution’s site, whose URL was http://www.internic.org, and, posing as Network
Solutions, offered to register domains for a fee of $250 while Network Solution’s fee was only
$100).

                                                   28
                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


deceptive information—for example charging a higher price than has been stated

on the website118—and misrepresentations regarding the product offered.119

Finally it is possible that merchants do not honor rights of return120 that they have

previously granted themselves or that are granted by law.121


And even when a merchant is not actually acting fraudulently, it will have to be

conceded        that   “from    time    to   time     things   go    wrong      in   cross-border

transactions.”122 Goods might arrive, but they may be defective or otherwise

unsatisfactory, and they might—especially during the holiday season123—arrive




118
   The story of David J. Loundy’s attempt to buy a rare CD of the group Level 42 from a British
Web site provides a fun-to-read example for this (although the merchant in that case presumably
did not actually have a fraudulent intent); see Carl S. Kaplan, On the Web, It’s Buyer Beware. But
Where?,        N.Y.      TIMES,      CYBER       LAW       JOURNAL      (March       26,    1999)
<http://www.nytimes.com/library/tech/99/03/cyber/cyberlaw/26law.html>.
119
   For a variety of examples for these and other practices see ACCC, Enforcement Challenge,
supra note 28, 15-19.
120
      See ACCC, Enforcement Challenge, supra note 28, at 11.
121
   Art. 6(1) of the Distance Contracts Directive, supra note 24, for example, grants consumers
the right to withdraw from any distance contract within a period of (at least) seven working days
without penalty and without giving any reason. The exercise of this right leads to an obligation of
the supplier to reimburse the sums paid by the consumer, see id. art. 6(2).
122
      See ACCC, Enforcement Challenge, supra note 28, at xi.
123
     See Connie Guglielmo, Consumer reluctant to rely on Net, ZDNet UK (Dec. 13, 1999)
<http://www.zdnet.co.uk/news/1999/49/ns-12127.html> (referring to a study by Jupiter
Communications finding that fears of orders being shipped late or that items will be out of stock
are two of the main reasons why most consumers will continue to do their holiday shopping
offline). These fears are obviously not ungrounded, see Saul Hansell, Toys ‘R’ Us Falls Behind on
Shipping,             N.Y.          TIMES,          Dec.           23,             1999,           at
<http://www.nytimes.com/library/tech/99/12/biztech/articles/23toy.html>. See also Louise Kehoe,
A          Valentine’s       Day         fiasco,      FT.com         (Feb.          20,       2000)
<http://news.ft.com/ft/gx.cgi/ftc?pagename=View&c=Article&cid=FT4KVRU4X4C>               (describing
Valentine’s day delivery problems of online greeting card providers and florists).

                                                 29
                    The Online-Marketplace: Shaking the Foundations of Consumer Confidence


late.124 Again, the risk of prior performance in all of these cases lies with the

consumer, who will have to take action to get his money back.


Unfortunately, these examples of fraudulent merchant behavior or of other

problems in the transaction to the consumer’s disadvantage are by no means

purely theoretical. They do happen in practice, and they do happen to an extent

that makes the danger of an erosion of consumer confidence in the electronic

marketplace appear more than likely. A list of the Federal Trade Commission’s

Enforcement Actions Involving the Internet and Online Services as of Dec. 15,

1999 shows 107 cases in which the Commission took action against fraudulent

merchant conduct.125 This list, of course, covers only a fraction of fraudulent

online conduct, as it is limited to enforcement actions of one enforcement agency

in one country and naturally does not include the presumably much larger

number of cases that have not been discovered (before the sites disappeared) or

in which enforcement actions have not been or could not be taken for various

reasons. A study by Consumers International, in which researchers from 11

countries placed a total of 151 orders from sites in 17 countries between

November 1998 and February 1999126 found that 9% of the goods ordered never




124
   See ACCC, Enforcement Challenge, supra note 28, at 11. See also Forrester Research, Inc.,
Press Release, eCommerce Could Be Hindered By Order Fulfillment Chaos (Aug. 26, 1999)
<http://www.forrester.com/ER/Press/Release/0,1769,160,FF.html>.
125
  See Federal Trade Commission, Commission Enforcement Actions Involving the Internet and
Online Services (Dec. 15, 1999) <http://www.ftc.gov/opa/1999/9912/case121599.pdf> [hereinafter
FTC, Cases].
126
   See Consumers International, supra note 93, at 19-22 (describing the methodology of the
study).

                                             30
                          The Online-Marketplace: Shaking the Foundations of Consumer Confidence


arrived;127 that in 20% of cases the amount actually charged was higher than the

purchaser expected;128 and that, where a return was possible,129 there were

problems in obtaining a refund of the purchase price in 21% of purchases.130

According to another survey,131 which was supported by the European

Commission, an even higher percentage of goods—18.1%—never arrived, and

of the goods that did arrive, 7% were either damaged or late;132 27.8% of

customers who returned goods did not receive a refund;133 and in 6% of the

cases in which payment was made by credit card, the account was charged but

the goods were never delivered.134 Moreover, with regard to telemarketing fraud

it has been found that it costs consumers an estimated fifteen billion to forty

billion dollars each year.135 And given the fact that the main factors that made

(and make) telemarketing fraud “a lucrative and profitable business for scam

artists”136 are believed to be the anonymity of the telephone and the ease of




127
      See id at 37. In one of these eleven cases (app. 1%) the consumer was charged nevertheless.
128
      See id at 35.
129
  In a number of cases the time limits for returning goods had elapsed before receipt of the item,
and in others the cost of returning was higher then the price of the item.
130
      See id at 39.
131
      See     Stiftung  Warentest,   Electronic   commerce     in       Europe (Sept.  1999)
<http://www.europa.eu.int/comm/dg24/library/surveys/sur11_en.pdf>.       The methodology is
described id. at 9.
132
      See id. at 39-40.
133
    See id. at 37. In over 90% of these cases the merchant gave no reason for the non-refund or
failed to reply, see id. at 36.
134
      See id. at 38.
135
      See Smythe, supra note 103, at 350 and sources cited therein.
136
      Id.

                                                 31
                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


escaping detection,137 one can only expect the problem to be aggravated in the

online environment.


These examples and findings suggest that there actually is sufficient reason for

consumers to not feel completely comfortable with shopping online. To this

background the commonly expressed concerns about a lack of consumer

confidence or consumer trust, which were referred to above,138 seem

plausible.139 But what do the terms “consumer confidence” and “trust” actually

mean, and what are they based upon?



B.          What is “Consumer Confidence”?

Electronic commerce140 ultimately is about completing transactions between

merchants and consumers. Putting it very simple, and leaving non-transactional

issues such as privacy141 aside, one can assume that a consumer enters into a

transaction (in our case an exchange of the consumer’s money for the




137
   Id. (citing Telemarketintg Fraud: Hearing Before the Subcomm. on Communications of the
Senate Comm. on Commerce, Science, and Transp., 102d Cong., 2d Sess. 4 (1992)).
138
   See supra text and notes following note 13. According to another survey cited by Leung, supra
note 21, “[t]he majority of retailers ... viewed lack of consumer confidence as their number one
concern.”
139
    Cf. Smythe, supra note 103, at 368 (asserting, with regard to telemarketing scams, that
“[p]ublicity about fraudulent telemarketers makes consumers generally more suspicious and
reluctant to purchase goods by telephone, and telemarketers may have difficulty regaining the
confidence of consumers who have been defrauded by unscrupulous scam artists” and citing
Hearing Before the Subcomm. on Transp. and Hazardous Materials of the House Comm. on
Energy and Commerce, 103d Cong., 1st Sess. 45 (1993) and H.R. Rep. No. 103-20, 103d Cong.,
1st Sess. 2 (1993)).
140
    As stated above, supra I, I will concentrate on business-to-consumer electronic commerce in
this paper.
141
      See supra notes 47-49.

                                              32
                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


merchant’s goods or services) only if she believes that “things go right”142 or that

“things can be fixed if they go wrong”.143 To be a little more specific in regard to

online transactions one can say that a rational consumer enters into a transaction

if she believes that she will actually get the goods (in the condition agreed upon)

or services she is about to pay for, or if she believes that something can be done,

that some remedy or some kind of redress is available, to prevent her from

incurring a permanent loss if she doesn’t get what she paid for.144


To be sure, not every consumer acts rational all of the time. Some might not care

and take a chance and just “try it out”, especially when the amount involved is

comparably small. But it seems fairly straightforward that this cannot be assumed

in the majority of cases, and that even those who do not care once or twice will

probably do so at some point (or they loose interest in trying it out altogether).

Moreover, the underlying expectation when taking a chance very often is that

things go right. Finally, even those who are generally skeptical about

neoclassical economics’ rational choice theory concede that it is “correct about



142
    See, e.g., OECD, Recommendation of the OECD Council Concerning Guidelines for
Consumer Protection in the Context of Electronic Commerce 2 (Dec. 9, 1999)
<http://www.oecd.org/dsti/sti/it/consumer/prod/CPGuidelines_final.pdf>     [hereinafter    OECD,
Consumer Protection Guidelines ] (explicitly “[r]ecognising that consumer confidence in electronic
commerce is enhanced by the continued development of transparent and effective consumer
protection mechanisms that limit the presence of fraudulent, misleading or unfair commercial
conduct online”).
143
     Cf. DOUGLASS C. NORTH, INSTITUTIONS, INSTITUTIONAL CHANGE, AND ECONOMIC PERFORMANCE
33 (1990) (“Enforcement poses no problem when it is in the interests of the other party to live up
to agreements. But without institutional constraints, self-interested behavior will foreclose
complex exchange, because of the uncertainty that the other party will find it in his or her interest
to live up to the agreement.”) (emphasis added).
144
   See also Froomkin, supra note 3, at 69 (listing “[c]omfort that there is recourse if the seller fails
to perform or deliver” among the buyer’s desires); W ORKING GROUP II, supra note 4, at 17


                                                  33
                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


eighty percent of the time.”145 This is more than enough for the general

tendencies that are explored in this paper.


Thus, the basic assumption is that consumers will engage in transactions if they

believe that they will get what they pay for or that something can be done if they

don’t. A similar idea is expressed in the passage from the U.S. Government’s

Global Framework for Electronic Commerce cited above.146 This section

emphasizes that “consumers must have confidence that the goods and services

offered are fairly represented, that they will get what they pay for, and that

recourse or redress will be available if they do not.”


1)          Trust and Reliance
These two expectations—expecting to get it, and expecting being able to fix it if

one doesn’t get it—need to be clearly distinguished. They can both be put under

the generic expression “consumer confidence” but it is important to realize that

they are two separate elements. They differ in the bases they are grounded on,

they differ in the addressees of the consumer’s respective expectations, they

differ in the way they are affected by the characteristics of online transactions,

and they differ in regard to the means that can be employed to enhance them.

The following refers to these two expectations, that together form consumer




(“Consumer confidence also requires that consumers have access to fair and effective redress if
they are not satisfied with some aspect of the transaction.”).
145
      See FRANCIS FUKUYAMA, TRUST 13, 17 (1995).
146
      See supra note 15.

                                              34
                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


confidence,147 as trust and reliance: Trust, if the consumer believes things will go

alright, reliance if she believes thinks might go wrong but can be cured if they do.

The distinction between trust and reliance is rarely clearly made in the literature,

although it has important implications. The following sections will explain in some

more detail, how the terms trust and reliance are used in this paper.


a)          Trust

As indicated above,148 the literature on trust is burgeoning.149 As this quantity

suggests, the authors look at trust not only from different points of view (for

example from an economical, psychological, or sociological perspective), but

also in very different contexts. Three—partly interrelated—prime areas of interest

appear to have evolved in the academic discourse on trust.150 The first and most



147
    The terminology as it is used in this paper does not claim apply generally. Others have, for
example, clearly distinguished confidence and trust. See, e.g., Niklas Luhmann, Familiarity,
Confidence, Trust: Problems and Alternatives, in TRUST(Gambetta ed.), supra note 23, at 94, 97
who differentiates between confidence and trust, asserting that the former relates to things that
cannot be influenced by an individual or in regard to which she does not consider alternatives,
while pertaining to the latter an individual chooses her own actions in preference to others in spite
of the possibility of being disappointed). See also Roger C. Mayer et al., An Integrative Model of
Organizational Trust, 20 ACAD. MGMT. REV. 709, 713 (1995) (referring to Luhmann, id.).
148
      See supra note 22.
149
   See, e.g., FUKUYAMA, supra note 145; TRUDY GOVIER, DILEMMAS OF TRUST (1998) [hereinafter
GOVIER, DILEMMAS OF TRUST]; TRUDY GOVIER, SOCIAL TRUST AND HUMAN COMMUNITIES (1997)
[hereinafter GOVIER, SOCIAL TRUST]; MARTIN HOLLIS, TRUST W ITHIN REASON (1998); TRUST W ITHIN
AND BETWEEN ORGANIZATIONS, supra note 22; TRUST IN ORGANIZATIONS: FRONTIERS OF THEORY
AND RESEARCH (Roderick M. Kramer & Tom R. Tyler eds., 1996) [hereinafter TRUST IN
ORGANIZATIONS]; Russell Hardin, Trust, in 3 THE NEW PALGRAVE DICTIONARY OF ECONOMICS AND
THE LAW 623 (Peter Newman ed., 1998) [hereinafter T HE NEW PALGRAVE]; TRUST (Gambetta ed.),
supra note 23; BERNHARD BARBER, THE LOGIC AND LIMITS OF TRUST (1983); JOHN O. W HITNEY, THE
ECONOMICS OF TRUST: LIBERATING PROFITS AND RESTORING CORPORATE VITALITY (1995);
PriceWaterhouseCoopers, E-Business: A Matter of Trust (1999) <http://www.e-
business.pwcglobal.com/pdf/trust.pdf> [hereinafter PWC, E-Business]; Bruce Chapman, Trust,
Economic Rationality, and the Corporate Fiduciary, 43 U. TORONTO L.J. 547 (1993).
150
   This is, of course, a very broad categorization, which is not meant to imply that these areas
are always clearly separable or independent of each other.

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                         The Online-Marketplace: Shaking the Foundations of Consumer Confidence


general focus of attention, which to some extent forms the underlying basis for

the others, is social trust. The level of trust in societies or communities as a

whole has stood in the center of Fukuyama’s,151 Hollis’152 and Govier’s153 work.

Govier further analyzed trust in personal relationships (friendship, family),154

while Fukuyama emphasizes the relation between social trust or “sociability” and

economic performance. He claims that “a nation’s well being, as well as its ability

to compete, is conditioned by a single, pervasive cultural characteristic: the level

of trust inherent in the society.”155 Thus, Fukuyama bridges the first focus of

attention with the second, trust within organizations.156 The argument goes that

within a company mutual trust and cooperation between, for example,

management and employees rather than tight controls, hierarchical power, or

surveillance enhance efficiency and productivity. 157 The third focus of the literary

discussion is trust in exchange relationships.158 It is this aspect of trust—more




151
      See FUKUYAMA, supra note 145.
152
   See HOLLIS, supra note 149, at 1 (citing and agreeing with John Locke, who “declared trust to
be ‘the bond of society’, the vinculum societas, ....”) (italics in the original).
153
      See GOVIER, SOCIAL TRUST, supra note 149.
154
      See GOVIER, DILEMMAS OF TRUST, supra note 149.
155
      See FUKUYAMA, supra note 145, at 7.
156
    Or intraorganizational trust. See, e.g., Jörg Sydow, Understanding the Constitution of
Interorganizational Trust, in TRUST W ITHIN AND BETWEEN ORGANIZATIONS, supra note 22, at 31
(distinguishing intra- and interorganizational trust).
157
      See, e.g., id. and the sources cited therein; FUKUYAMA, id. at 231.
158
   See generally, Mari Sako, Does Trust Improve Business Performance?, in TRUST W ITHIN AND
BETWEEN ORGANIZATIONS, supra note 22, at 88 (conceptualizing interorganizational trust into
contractual trust, competence trust, or goodwill trust according to its sources); Julia Porter
Liebeskind & Amalya Lumerman Oliver, From Handshake to Contract: Intellectual Property, Trust,
and the Social Structure of Academic Research, in TRUST W ITHIN AND BETWEEN ORGANIZATIONS,
supra note 22, at 118, 121 (defining “interpersonal trust” as trust that is directly engendered when
two actors are involved in an exchange relationship over time); Simon Deakin & Frank Wilkinson,
Contract Law and the Economics of Interorganizational Trust, in TRUST W ITHIN AND BETWEEN
                                                36
                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


specifically the trust among the partners of a (future) business transaction—that

is of interest in the context of this paper. And although most authors to date have

concentrated on trust between organizations or interorganizational trust,159 it is

no question that similar issues arise in regard to transactions between individuals

or between individuals and organizations—in our context between a consumer

and a merchant potentially engaging in a business transaction over the Internet.

Thus, trust in exchange relationships or interpersonal trust160 appears to be the

more appropriate terminology in our context.


As discussed above, there are different types of trust and numerous perspectives

and contexts from and in which trust can be analyzed. Thus, it is hardly

surprising that one can find almost as many definitions and perceptions of trust

as authors that have written on it. Brenkert, for example, identifies the different

understandings of trust, which have been used in the literature as “the Attitudinal,

Predictability, and Voluntarist senses of trust.”161 Rejecting the first two, he favors

the Attitudinal sense of trust which basically involves an attitude to act in certain

ways in light of the beliefs one has about one’s own vulnerability and the other

party’s restraint to take advantage of that vulnerability.162 Similarly, according to




ORGANIZATIONS, supra note 22, at 146; Mayer et al., supra note 147, at 711 (speaking of “the
relationship between two specific individuals and the reasons why a trustor would trust a trustee”
and of interpersonal trust).
159
      See sources cited supra note 158.
160
      See authors cited supra note 158.
161
      See, e.g., George G. Brenkert, Trust, Morality, and International Business, in TRUST W ITHIN
AND BETWEEN ORGANIZATIONS,     supra note 22, at 272, 274-277.
162
      See id. at 274.

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                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


Govier, “[t]rust is fundamentally an attitude, based on beliefs and feelings and

implying expectations and dispositions.”163 For Fukuyama, who focuses on social

trust and thus has a much broader approach, “[t]rust is the expectation that

arises within a community of regular, honest, and cooperative behavior, based on

commonly shared norms, on the part of the other members of that community.” 164

As indicated before, there are many other definitions of trust, some more similar

to these and some less, some stressing certain factors more and others less.165


It is not my focus here, to add another general definition of trust. In fact, given the

versatility of approaches to trust, it appears dubious whether one can satisfyingly

define trust outside a specific context at all.166 Therefore I will confine myself to

pointing out the characteristics of trust that appear most relevant in regard to

business transactions, thus clarifying how trust is understood in the context of

this paper. These key characteristics are uncertainty, risk, and expectations with

regard to a transaction and the partner to that transaction. To some extent these




163
   See GOVIER, SOCIAL TRUST, supra note 149, at 3. See also GOVIER, DILEMMAS OF TRUST, supra
note 149, at 6 (“Trust is in essence an attitude of positive expectation about other people, a sense
that they are basically well intentioned and unlikely to harm us.”).
164
      See FUKUYAMA, supra note 145, at 26.
165
    See also Hardy et al., supra note 22, at 69 (conceptualizing trust in terms of communication,
predictability and goodwill and defining it as a “communicative, sense-making process that
bridges disparate groups” and that can be said to exist between partners, “when relations involve
a high degree of predictability, on all sides, that the others will not engage in opportunistic
behavior.”); Christel Lane, Introduction: Theories and Issues in the Study of Trust, in TRUST
W ITHIN AND BETWEEN ORGANIZATIONS, supra note 22, at 1. 4-14 (discussing a number of different
views of trust).
166
    Cf. Reinhard Bachmann, Conclusion: Trust—Conceptual Aspects of a Complex Phenomenon,
in TRUST W ITHIN AND BETWEEN ORGANIZATIONS, supra note 22, at 298, 299-301 (conceding the
difficulties to find suitable terms for a social mechanism which is as complex and
multidimensional as the concept of trust).

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                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


elements can be regarded as a “common denominator” of most otherwise

varying definitions of trust.167


The first element of a trust relationship is uncertainty as to the other side’s future

behavior. In this respect I agree with Brenkert in rejecting the Predictability view

of trust.168 If one can actually “predict accurately the behavior of the person

trusted”,169 there is no need for trust.170 In fact, if I knew accurately that the other

would not keep her promise, I would do anything but trust him. Thus, knowing

and trusting are two different and mutually exclusive states of mind. It is the lack




167
    See also Lane, supra note 165, at 3 (stating that “most concepts of personal trust share three
common elements.” According to Lane these elements are a degree of interdependence, the
presence of risk or uncertainty, and a belief or expectation that the trusting party’s vulnerability
will not be taken advantage of by the other party); Humphrey, supra note 23, at 216-17 (finding
that “[t]he many available definitions of trust have two core elements: an agent’s acceptance of
risk from the actions of others, and the expectation that the ‘partner’ will not take advantage of the
opportunities opened up by the agent’s acceptance of risk.”); Mayer et al., supra note 147, at 712
(defining trust as “the willingness of a party to be vulnerable to the actions of another party based
on the expectation that the other will perform a particular action important to the trustor,
irrespective of the ability to monitor or control that other party”).
168
    See Brenkert, supra note 161, at 276. See also Virginia Held, On the Meaning of Trust, 78
ETHICS 156 (1968) (Held disagrees with Gordon Tullock, The Prisoner’s Dilemma and Mutual
Trust, 77 ETHICS 229 (1967) whom she interprets as follows: “He [Tullock] proceeds to consider
the term ‘trust’ to mean, in effect, being able to predict accurately the behavior of the person
trusted, ....” Held, id. at 157, goes on to argue that “trust seems to have more to do with situations
of uncertainty than with situations of certainty.”); Dasgupta, supra note 23, at 51 (conceiving of
trust as “correct expectations about the actions of other people”) (emphasis added) (emphasis in
original omitted); HOLLIS, supra note 149, at 10 (“[T]rust is simply a matter of predictability.” Hollis
distinguishes two varieties of trust, however, the second being perceived as expecting another
person to or predicting that she will “do what is right.”); Note, however, that some authors who
speak of “predictability” use the term in the sense of “expectation”. See Hardy et al., supra note
165, at 66 (referring to NIKLAS LUHMANN, TRUST AND POWER (1979) who argues “that we make
predictions (or have expectations) concerning the behavior of others”).
169
      See Held, supra note 168 (citing Tullock).
170
   See Mayer et al., supra note 147, at 711 (“The need for trust only arises in a risky situation.”).
Cf. Dasgupta, supra note 23, at 51 (arguing that trust loses its potency when one can monitor
what others have done before choosing her own action); LUHMANN, supra note 168, at 33 (arguing
that the clues employed to form trust do not eliminate, but just reduce the risk, that they do not
supply complete information about the likely behavior of the person to be trusted, and that they
simply serve as a “springboard for the leap into uncertainty”) (emphasis added).

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                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


of accurate knowledge or predictability that brings about the question of whether I

should or should not trust someone to begin with.


Without uncertainty there would also be no risk, which is the second, though

inseparably related to the first, element of trust in exchange relationships. Not

only is trust not needed, when one knows the other party’s behavior, i.e. when

absent any uncertainty, but, moreover, “[t]rust is only required if a bad outcome

[of the other’s uncertain behavior] would make you regret your action”,171 i.e.

when a risk exists. Risk is, in fact, “one of the few characteristics common to all

trust situations.”172 Risk “arises because trusting behaviour exposes the agent to

the presumed opportunistic behaviour of her business partner.”173 The trusting

party will typically make a precommitment of some kind174 and runs the risk of




171
    Luhmann, supra note 147, at 98. See also LUHMANN, supra note 168, at 25 (arguing that trust
is involved in those expectations that concern conduct in the light of which one commits one’s
own actions and which if unrealized lead one to regret one’s behavior).
172
   Mayer et al., supra note 147, at 712. See also Sydow, supra note 156, at 35 (“Trust, ..., is
always associated with a particular risk on the side of the trusting party.”) (also citing et al.,
supra). The fact that the notion of risk is present in almost every definition of trust has already
been indicated, see supra note 167.
173
      Lane, supra note 165, at 3.
174
    See LUHMANN, supra note 168, at 25. A precommitment in a literary sense is not compelling,
however. As Hofstadter’s alteration of the original prisoner’s dilemma to a trader’s dilemma vividly
illustrates, simultaneous but secret actions will raise the same issues of trust; see DOUGLAS R.
HOFSTADTER, METAMAGICAL THEMAS: QUESTING FOR THE ESSENCE OF MIND AND PATTERN 715
(1985): “Assume you possess copious quantities of some item (money, for example), and wish to
obtain some amount of another item (perhaps stamps, groceries, diamonds). You arrange a
mutually agreeable trade with the only dealer of that item known to you. You are both satisfied
with the amounts you will be giving and getting. For some reason, though, your trade must take
place in Secret. Each of you agrees to leave a bag at a designated place in the forest, and to pick
up the other’s bag at the other’s designated place. Suppose it is clear to both of you that the two
of you will never meet or have further dealings with each other again. Clearly, there is something
for each of you to fear: namely, that the other one will leave an empty bag.” See also Dasgupta,
supra note 23, at 51 (pointing out that it is the “inability to monitor others’ action” that is crucial to
the definition of trust and that this inability will in many cases be “be due to the fact that my choice
of action temporally precedes those of others”, but not in all of them).

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                         The Online-Marketplace: Shaking the Foundations of Consumer Confidence


suffering a loss, if the other party (the trustee) does not keep her promise or does

not live up to her obligation in the exchange. Thus, “[t]rust is a risky business

because the people whom we trust can let us down, and we are vulnerable to

harm when they do so.”175


One takes this risk because of one’s expectations—the most important element

of trust. The trusting party expects the trustee not to take advantage of or exploit

her vulnerability.176 She believes her, the trustee, not to behave opportunistically

and benefit from her, the trustor’s, precommitment without keeping her own

promise. In other words, trust entails the belief that for some reason177 the

trusted party does not go for a probably greater immediate advantage, i.e. getting

something for nothing, but gives something in return, thereby reducing her own

advantage but making it a mutually beneficent relationship.178 And again,179 could

the other party’s behavior be accurately predicted (instead of just having

expectations) there would be no need for trust. Accordingly, Baier defines trust




175
   GOVIER, DILEMMAS OF TRUST, supra note 149, at 8. See also LUHMANN, supra note 168 (“Trust
remains a risky undertaking.”).
176
   See, e.g., Lane, supra note 165, at 3; Sako, supra note 158, at 89; Humphrey, supra note 23,
at 217. See also Annette Baier, Trust and Antitrust, 96 ETHICS 231, 235 (1986) (“[T]rusting does
require awareness of one’s confidence that the trusted will not harm one, although they could
harm one.”).
177
      We will come back to the bases of trust in detail below, see infra II.D.
178
   See also HOFSTADTER, supra note 174, at 715 (Referring to the “bags-in-the-forest” example
restated herein supra note 174 and describing this situation as follows: “Obviously, if you both
leave full bags, you will both be satisfied; but equally obviously, getting something for nothing, is
even more satisfying.”).
179
      See supra note 169 and accompanying text.
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                             The Online-Marketplace: Shaking the Foundations of Consumer Confidence


as “accepted vulnerability to another’s possible but not expected ill will (or lack of

good will) toward one.”180


Finally, trust in exchange relationships, as opposed to reliance as it is understood

in this paper,181 is bilateral. That means trust typically exists (if it exists) in the

other party, while one would rely on a third party.


Coming back to our initial assumption,182 it is now more apparent that in our

context trust is the expectation that “things will go right”. The potential transaction

between a consumer and an online merchant is a typical exchange relationship

entailing all the characteristics just described. Uncertainty exists as to the

merchant’s future behavior. In fact, the uncertainty is even greater than it is in

offline transactions since the consumer might not even have any knowledge

about the merchant’s identity or physical location. The fact that the consumer is

typically required to make an advance payment183 puts her at risk to lose her

money without subsequently getting the goods or services she paid for. The

consumer bears the risk of prior performance referred to above.184 It is the

consumer who makes the precommitment that, according to Luhmann,




180
      Baier, supra note 176, at 235 (emphasis added).
181
      See infra II.B.1)b).
182
      See supra text following note 141.
183
      See supra note 93 and accompanying text.
184
      See supra note Fehler! Textmarke nicht definiert. and accompanying text.

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                         The Online-Marketplace: Shaking the Foundations of Consumer Confidence


characterizes potential trust relationships.185 In other words, when applying

Hofstadter’s trader’s dilemma186 to online transactions between a merchant and a

consumer, the result is that not only would the consumer often not know where to

look for the merchant’s bag, but also can the merchant check the consumer’s

bag before leaving its own (thus, it might take mine and not leave its at all). The

better parallel, therefore, seems to be the typical—and highly uncomfortable—

blackmail or extortion situation. I deposit my bag with the ransom in the forest

and then I am at the blackmailer’s mercy that she doesn’t kill the hostage anyway

(one might say I have to trust her, but that seems somewhat sarcastic in regard

to a blackmailer). Moreover, the Internet makes it much easier for the blackmailer

to pick up my bag without being trapped or identified.


In sum—unless she can rely on a third party to fix things that have gone

wrong187—a consumer needs to have trust in a merchant is she to enter into an

online transaction with it. She needs to expect the merchant not to take

advantage of her exposing herself to the risk of paying in advance for goods and

services that the merchant, subsequently, might or might not actually provide. To

this background the most important question becomes, what these expectations,

what the consumer’s trust can be based upon.188 At this point one generally very




185
    See supra note 174. For Luhmann this is a general rule. Building up trust requires a mutual
commitment which will take place “in a fixed order, first the truster and then the trustee.” See id.
at 42.
186
      See supra note 174.
187
      We will turn to this second alternative immediately, see infra II.B.1)b).
188
      See infra II.D.

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                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


important189 basis of trust can already be excluded: a personal impression of the

potential trustee. In regard to non face-to-face remote transactions over the

Internet, you simply cannot rely on your intuition telling you whether or not to trust

someone after seeing her—because you never see her.190 Before analyzing

other possible bases of trust, however, we will first turn to its counterpart—

reliance.


b)          Reliance

If the consumer does not expect things to go right, that is if she does not really

trust the merchant (the consumer might still hope that the merchant keeps its

promise, but she does not really know enough; she has no sufficient basis, to

expect it to do so) she might still enter into the transaction under the condition

that she can rely on someone or some mechanism to fix things should they go

wrong. Note that this was the second part of the basic assumption made earlier

in this paper.191 Sometimes reliance is used as a synonym for trust. This is, for

example, the case when authors speak of an agent believing in the reliability of




189
    See GOVIER, DILEMMAS OF TRUST, supra note 149, at 125 (arguing that direct personal
knowledge has a higher status than, for example, media-based knowledge because it is based on
a multidimensional experience allowing an impression of the whole person by seeing her, making
eye contact, hearing her voice, seeing and sensing her gestures, movements, and responses
etc.).
190
    See GOVIER, DILEMMAS OF TRUST, supra note 149, at 7 (Describing personal experience as
one possible basis for trust: “Often we have an intuitive sense of whom we can trust and whom
not, relying on a lifetime of experience of human expressions, gestures, and character. One might
say ... ’The moment I saw him, I knew I could trust him.’”). See also Nancy R. Furnari, Are
Traditional Agency Principles Effective for Internet Transactions, Given the Lack of Personal
Interaction?, 63 ALB. L. REV. 537, 542 (1999) (arguing that in regard to Internet transactions, with
the lack of face-to-face contact, “the key element of trust is also missing”).
191
      See supra text following note 141.

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                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


his trustee,192 or when they ask “how far people can be relied on to do what is

expected from them.”193 This is not how “reliance” will be used here. Rather, trust

and reliance will be understood as counterparts and reliance is assumed to

always involve a third party or an external institution,194 while trust is bilateral.195

Reliance comes into play when the basis for trust is not sufficient.196 When I do

not or cannot expect things to go right, I rely on a third party or institution to fix

things should they go wrong—to control the partner of my transaction, to coerce

her to keep her promise, or to afford me redress, preventing me from incurring a

permanent loss (for example by retrieving my advance payment).197 Reliance

thus reduces the risk inherent in exchange relationships;198 it can “compensate




192
      See, e.g., Deakin & Wilkinson, supra note 158, at 147.
193
      HOLLIS, supra note 149, at 11.
194
     See also FUKUYAMA, supra note 145, at 341 (arguing that “[t]he moment that trust breaks down
... third parties [have to be] brought in to resolve differences”) (emphasis added). Cf. NORTH,
supra note 143, at 34 (“The greater the specialization and the number and variability of valuable
attributes, the more weight must be put on reliable institutions that allow individuals to engage in
complex contracting with a minimum of uncertainty about whether the terms of the contract can
be realized. Exchange in modern economies ... necessitates institutional reliability, ....”)
(emphasis added); Mayer et al., supra note 147, at 713 (arguing that parties “don’t really trust ...
[i]f there are external control mechanisms that will punish the trustee for deceitful behavior”).
195
      See supra text following note 181.
196
    Cf. FUKUYAMA, supra note 145, at 25 (Fukuyama expresses something similar when he says:
“Hierarchies are necessary because all people cannot be trusted at all times to live by
internalized ethical rules and do their fair share. They must ultimately be coerced by explicit rules
and sanctions in the event they do not live up to them.”).
197
    Cf. Hardin, supra note 149, at 624 (“[T]hat it would be in your interest to do X because the law
would coerce you, would be grounds for me to rely on you—but reliance is not trust ....” The
difference between Hardin’s use of “reliance” and the use herein lies in the addressee: While
Hardin would rely on you (being coerced), I would rely on the law (to coerce you).) (emphasis in
the citation added).
198
   Cf. LUHMANN, supra note 168, at 34 (Luhmann asserts that “legal arrangements which lend
special assurance to particular expectations, and make them sanctionable, ... lessen the risk of
conferring trust.”) (footnote omitted).

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                          The Online-Marketplace: Shaking the Foundations of Consumer Confidence


for an absence of trust”.199 It can, in effect, substitute trust200 or, as Bluhm put it,

“[i]f one believes that potential negative consequences can be neutralized (...), it

matters little if the person with whom one is interacting is untrustworthy.” 201

Instead of reliance one could certainly use terms like “control”, “coercion”, or

simply “non-trust”. But all of these terms, it seems to me, just cover specific parts

of what I mean by “reliance”.


c)           Some Economics of Trust and Reliance

It is frequently alleged that trust increases efficiency by reducing transaction

costs.202 Macaulay’s quote of a lawyer saying that he was “sick of being told, ‘We




199
    FUKUYAMA, supra note 145, at 26 (Fukuyama refers to “legal mechanisms like contracts”
which, in the understanding proposed here, would be one institution to rely on in the absence of
trust. In fact, it should be clarified that the mechanisms would not be just contracts, but
enforceable contracts. Stewart Macaulay, Non-Contractual Relations in Business: A Preliminary
Study, 28 AM. SOC. REV. 55, 56 (1963) uses the term “contract” in the latter sense when he
defines it as involving “the existence or use of actual or potential legal sanctions to induce
performance of the exchange or to compensate for non-performance.”). Cf. Baier, supra note
176, at 251 (Baier argues that contracts offer the trusting party security, making it possible “to
trust with minimal vulnerability.” Contracts “are a device for trusting others ... without taking the
risks trusters usually do take. They are designed for cooperation between mutually suspicious
risk-averse strangers.” I only disagree with Baier’s terminology. This trust between “mutually
suspicious risk-averse strangers” is not only “a limit case of trust” (id.) but not trust at all. It is, in
the terminology used here, reliance on the contract and the possibility of its enforcement.)
200
      See id. at 27 (referring to the “legal apparatus, serving as a substitute for trust”).
201
    Bluhm, supra note 33, at 338 (listing guarantees, insurance, or warranties as mechanisms that
are designed to negate the unfavorable consequences which might follow from risking
interaction). Something similar is expressed by LUHMANN, supra note 168, at 34 when he says
that, “if contracts are to be trusted it is necessary that their performance be made independent of
the question of who, if anybody, has in fact trusted.” In other words, reliance on external
institutions can make trust between the transacting partners irrelevant, but it may require trust in
the institution itself (to actually be reliable). Luhmann’s terminology, however, still differs
somewhat from the concept proposed herein when he refers to legal regulation as the “safeguard
of trust” (id. at 35).
202
   See FUKUYAMA, supra note 145, at 151; Sako, supra note 158, at 91; Deakin & Wilkinson,
supra note 158, at 147 (“[T]rust may contribute to operational efficiency by reducing transaction
costs which are associated with relational contracting.”).

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                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


can trust old Max’”203 can be understood to support that allegation (since the

transaction costs are reduced on the lawyer’s expense who would otherwise draft

an agreement). Without trust, parties to a transaction will deal with one another

only under a system of formal rules and regulations, they need to negotiate

detailed contracts, which they might have to litigate and enforce.204 This view,

while pointing out the major benefits of trust, completely neglects that there are

also costs to trust.205 First, the trustor is at risk that her expectation as to the

trustee’s behavior was wrong; that the latter turned out not to be trustworthy after

all. The risk inherent to trusting someone then materializes and a harm or loss is

incurred. Second, there are the costs of establishing trust and assessing

trustworthiness. Building trust requires time and resources to gather and verify

information about the potential trustee. These two cost factors are directly related

to one another. The less one invests in establishing trust and assessing

trustworthiness, the greater is the risk of being wrong and incurring a loss. Even

under Fukuyama’s premise that a basic level of trust is inherent in any society,

the need to establish trust and assess trustworthiness in regard to specific

transactions remains, because, as Fukuyama himself points out, in any society




203
      Macaulay, supra note 199, at 58.
204
   See FUKUYAMA, supra note 145, at 27, 151, 200. See also Humphrey, supra note 23, at 217
(“Entering into an economic exchange exposes the agent to risks arising from the action of
others. If these risks are uncontrollable, then exchange is reduced, paralysed, or rendered costly
by the need to take precautions. If the ‘other’ can be trusted, exchange is facilitated.”).
205
    The online lectures by Tamar Frankel on Benefits, Costs and Risks to Trusting and Non-
trusting,              available            at               <http://eon.law.harvard.edu/cgi-
bin/courseware/syllabus.cgi?COURSEID=25> provided many valuable ideas for this section.

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                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


“all people cannot be trusted at all times”.206 Therefore, at least at an initial stage,

it is misleading when Fukuyama asserts that trust reduces “transaction costs,

incurred by activities like finding the appropriate buyer or seller”.207 At the

beginning of a trust relationship there will be costs of finding the appropriate

trustee. Only when the parties, once trust has been established, engage in

repeated transactions with each other, will they incur less costs in these

subsequent transactions. Once they turn to a new or another partner, however,

they will have to bear the costs of establishing trust and assessing

trustworthiness again. Thus, trust involves a relatively high investment at the

beginning of the relationship, while it can make subsequent transactions between

the same partners more efficient.


In regard to reliance, it is the other way round. There are no initial costs of

establishing a relationship. In fact, relying on third parties or institutions to protect

one from incurring a loss “allow[s] strangers with no basis for trust to work with

one another”.208 On the other hand, reliance may entail relatively greater costs

for each transaction, for example costs of negotiating and forming detailed

contracts and, most importantly, enforcing one’s rights in the event of the other




206
      FUKUYAMA, supra note 145, at 25.
207
   Id. at 151. See generally RONALD H. COASE, THE FIRM, THE MARKET, AND THE LAW 114 (1988)
(Giving the classic definition of transaction costs: “In order to carry out a market transaction, it is
necessary to discover who it is that one wishes to deal with, to inform people that one wishes to
deal and on what terms, to conduct negotiations leading up to a bargain, to draw up the contract,
to undertake the inspection needed to make sure that the terms of the contract are being
observed, and so on.”).
208
   Id. at 150 (Fukuyama, in the sentence partly cited in the text, refers to contracts. I would put a
greater emphasis on the actual enforceability of contracts).

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                     The Online-Marketplace: Shaking the Foundations of Consumer Confidence


party’s not keeping her promise.209 These costs are the price for reducing the risk

inherent to trusting.


A generalization that trust (always) increases efficiency cannot be made.

Whether trust or reliance is more efficient depends on a number of factors: the

costs of establishing trust, assessing trustworthiness and the risk of trusting; the

costs of enforcement, coercion, or redress when relying on these means of risk

prevention; and, of great importance, the number of transactions between the

same partners. If the parties will engage in numerous similar transactions in the

future, the up-front investment in establishing a trust relationship might pay off

because of future savings in transaction costs. If the parties, however, will

engage in only one or a small number of transactions, the investment in building

trust might exceed the subsequent savings in transaction costs. This would make

it more efficient for the parties not to invest in trust, but to rely on (in the sum

relatively less expensive) means of coercion or redress in the event that things

go wrong.


This also suggests, that building trust and establishing trustworthiness might

have a different value for consumers and merchants, respectively.210 A merchant



209
   See generally NORTH, supra note 143, at 27 (emphasizing that transaction costs “consist of the
costs of measuring the valuable attributes of what is being exchanged and the costs of protecting
rights and policing and enforcing agreements”) (emphasis added).
210
    See generally Jay B. Barney & Mark H. Hansen, Trustworthiness as a Source of Competitive
Advantage, 15 STRATEGIC MGMT. J. 175, 176 (1994) (perceiving of trust as the attribute of a
relationship between exchange partners and of trustworthiness as an attribute of individual
exchange partners); Mayer et al., supra note 147, at 716-724 (discussing the concept of
trustworthiness the relevant factors pertaining to it). Mayer et al. also point to the difference
between trust (which is understood as one person’s trusting, as opposed to Barney & Hansen
who understand it as a trust relationship) and trusting behavior. In regard to the former one does
                                                 49
                          The Online-Marketplace: Shaking the Foundations of Consumer Confidence


will, by definition, engage in repeated transactions with consumers. From its point

of view it does not really make a difference, who the individual consumer is.

Thus, it would presumably be efficient for the merchant to establish a general

impression of trustworthiness, because it might facilitate all future transactions

with consumers in general. Thus, especially for merchants trustworthiness or

reputation211 is a valuable business asset.212 The consumer, on the other hand,

is not likely to deal with only one merchant, but with many different ones. So she

would have to establish trust in each of these merchants. Given the fact, that the

number of repeated transactions with any single merchant is limited, that might

not be an efficient thing to do (because the costs of building trust in each

merchant would exceed the transaction costs savings in future dealings with

each of them).


Thus, before turning to bases of trust and means of reliance and to ways to

enhance consumer confidence keep the following in mind. Consumer confidence

and efficiency can be increased in more than one way. Enhancing trust (and



not need to risk anything, while the latter involves taking a risk in order to engage in a trusting
action. In other words, there is a difference between “a ‘willingness’ to assume a risk and actually
‘assuming’ a risk.” See id at 724.
211
      See infra II.D.3) (discussing the role of reputation in greater detail).
212
    Cf. KENNETH J. ARROW , THE LIMITS OF ORGANIZATION 23 (1974) (“Now trust has a very
important pragmatic value, if nothing else. Trust is an important lubricant of a social system. It is
extremely efficient; it saves a lot of trouble to have a fair degree of reliance on other people’s
word. Unfortunately this is not a commodity which can be bought very easily. If you have to buy it,
you already have some doubts about what you’ve bought. Trust and similar values, loyalty or
truth-telling, are examples of what the economist would call ‘externalities’. They are goods, they
are commodities; they have real, practical, economic value; they increase the efficiency of the
system, enable you to produce more goods or more of whatever values you hold in high esteem.
But they are not commodities for which trade on the open market is technically possible or even
meaningful.”). Barney & Hansen, supra note 210. FUKUYAMA, supra note 145, at 10 (arguing that


                                                      50
                     The Online-Marketplace: Shaking the Foundations of Consumer Confidence


reducing the costs of establishing trust and assessing trustworthiness) is one

way that might work in some cases. Reducing the costs of reliance, particularly

enforcement costs, however, is another that might work in others. If, for example,

the costs of reliance are sufficiently low and the costs of establishing trust are

sufficiently high and if (from the consumer’s perspective) a relatively small

number of transactions with the same partner occurs, reliance is clearly

preferable over trust (if one has to make an either/or decision). In practice the

decision will to a large extent depend on which costs can be reduced more

easily. Examples for both approaches will be analyzed in part III.


2)       Enforcement and Compliance
It has become obvious from the above that trust and reliance are closely

connected to enforcement and compliance. To clarify this connection a little

more, it is helpful to look in some more detail at what means of enforcement are

available and at how enforcement and compliance relate to each other.


Robert Ellickson developed a system of social control in which he identifies five

different sets of rules, namely personal ethics, contracts, norms, organization

rules, and law. These rules are provided by five different controllers, namely the

actor (first-party control), the person acted upon (second-party control), social

forces (third-party control), organizations, and governments, respectively. Finally,

each of these controls can employ a corresponding enforcement mechanism.




“trust has a large and measurable economic value”); Dasgupta, supra note 23, at (“[T]rust is not
dissimilar to commodities such as knowledge or information.”).

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                     The Online-Marketplace: Shaking the Foundations of Consumer Confidence


These are self-sanction, personal self-help, vicarious self-help, organization

enforcement, and state enforcement. Altogether this leads to five combined

systems of social control: self-control, promisee-enforced contracts, informal

control, organization control, and the legal system.213 Only with regard to the

control system of promisee-enforced contracts, to which Ellickson assigns the

enforcement mechanism of personal self-help, would I propose a slight alteration.

Personal self-help, understood literally, is—subject only to very narrow

exceptions in events requiring immediate action—not accepted by most modern

states. If a seller refuses to deliver to a buyer what she is entitled to according to

their contract, the law does not allow the buyer to take it from the seller on her

own initiative. In enforcing her contract, she depends on the legal system and its

institutions.214 She will have to involve the courts and ultimately she might need

state enforcement. The difference therefore, between what Ellickson calls

second-party control and promisee-enforced contracts on the one hand and

government control and state enforcement on the other, lies only in the initiator.

State enforcement, in the sense in which it is used by Ellickson, takes place upon

an autonomous decision of the state’s respective authorities. “Personal self-help”

takes place upon the initiative of an individual (for example a contractor) who

uses—and has to use—the legal system (contract law, courts, and enforcement



213
   See ROBERT C. ELLICKSON, ORDER W ITHOUT LAW 124, 131, 143 (1990). This system has been
widely accepted, see, e.g., NORTH, supra note 143, at 6, 39-40 and in fact been recognized long
before Ellickson, see HENRY M. HART, JR. & ALBERT M. SACKS, THE LEGAL PROCESS 121-22
(1994).
214
   But see Edward L. Rubin, The Nonjudicial Life of Contract: Beyond the Shadow of the Law, 90
NW. U. L. REV. 107, 126-30 (1995) (discussing more innovative forms of self-help like taking
assets as a hostage—but also emphasizing the boundaries of self-help).
                                              52
                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


authorities) as the ultimate means to enforce her rights. Since the second party’s

action can be based on contract or tort law I will speak of this enforcement

system as court enforcement in general.


Understood in this way, Ellickson’s system of social control reveals a dichotomy.

One group, containing “personal self-help”, vicarious self-help, organization

enforcement, and state enforcement, is characterized by the fact that

enforcement requires the involvement of a third party or institution.215 This third

party is a state authority—acting on its own initiative or on a contract promisee’s,

a (private) organization, or agents from the social environment. In the other

“group”, which includes first-party self-sanction, enforcement is completely left to

its subject, in our context the contract promisor. With this dichotomy in mind, this

paper will speak of enforcement and compliance,216 respectively.


The parallel of this system to the conception of reliance and trust as laid out

above now becomes more apparent. In fact, compliance is the prime basis of

trust and the third parties or external institutions that provide for enforcement are

the addressee of an agent’s reliance.217 If the consumer believes in the

compliance of the merchant, she will enter into the transaction because of her

trust in it. If she believes in effective enforcement in the event something goes

wrong, she relies on institutions to prevent her from incurring a permanent loss.



215
      See also infra text accompanying note 215.
216
      See also infra note 484 (discussing compliance or self-enforcing contracts).
217
   See supra note 194 and accompanying text for the perception in this paper that reliance
always involves a third party or an external institution, whereas trust is always bilateral.

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                           The Online-Marketplace: Shaking the Foundations of Consumer Confidence


But can enforcement and compliance still serve as a sufficient basis for reliance

and trust—or, in short, for consumer confidence—in the online marketplace? The

answer to this question will depend on whether enforcement by any of the

traditional external control systems218 is effective in this environment;219 on

whether and to what extent compliance can generally be expected from online

merchants;220 and on whether and how a certain level of compliance on the

merchants’ side will actually lead to a corresponding level of trust on the

consumers’ side.221



C.           Enforcement and Compliance in the Online-Marketplace

Above, the paper pointed out some characteristics that are peculiar to online

transactions.222 Recall some of those characteristics in the context of effective

rule enforcement. First, buyers face uncertainty as to a seller’s identity or actual

physical location. Nothing on a website reliably indicates who is responsible for

its contents and from where it is operated. In fact, sophisticated ways exist to

make it virtually impossible to trace data on the web back to its point of origin (or

the physical location of its originator).223 In addition to this anonymity—and




218
      For a discussion of new external enforcement institutions see infra III.B.
219
      See infra II.C.1).
220
      See infra II.C.2).
221
      See infra II.D.
222
      See supra II.A.
223
   See supra text following note 115. See also Rothchild, supra note 31, at 927-28 (describing a
variety of techniques to disguise one’s identity in online communications).

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                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


related to it—the web is characterized by unprecedented mobility.224 Online,

because of the difficulties to track the physical location of a website operator, it is

not necessary to abandon a physical place of business or a “boiler room,”225 from

which fraudulent telemarketing schemes are operated, when the word of the

fraudulent nature of the business has spread. The fraudster merely needs to shut

down its website (easy exit).226 Escaping detection on the web is easier than

ever. And because of the low entry barriers (setting up a new site requires next to

no investment and can be done immediately) it is also easier than ever to

continue the fraudulent activity under a slightly altered design (easy entry and

low operating costs). The lack of physical assets (or the lack of knowledge

regarding their whereabouts) that could otherwise be attached is another

obstacle to enforcement in the online environment.227 Finally, the Internet is

characterized by an unprecedented globality. The perspective of reaching a

global market (the FTC speaks of a “target-rich environment”) 228 at very low

costs229 makes it attractive for both honest merchants and fraudsters to do their

(respective) “business” online (presenting a lucrative opportunity). At the same




224
    Cf. FTC, First Five Years, supra note 106, at 4 (“In the electronic marketplace, frauds can
appear suddenly, spread rapidly, and disappear without notice or warning.”); Rothchild, supra
note 31, at 926-27 (identifying and describing “portability” as one characteristic that makes it easy
to evade detection).
225
    See Smythe, supra note 103, at 351 (explaining the term “boiler room” in the context of
telemarketing fraud).
226
      See supra note 114.
227
      See Froomkin, supra note 3, at 71.
228
      See FTC, New Tools of the Trade, supra note 50, at 8.
229
   See supra note 114 (citing summaries why the Internet is such an attractive place to—also—
do illegitimate business).
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                           The Online-Marketplace: Shaking the Foundations of Consumer Confidence


time it will make enforcement agencies realize the limits of their jurisdiction very

quickly. In sum, the Internet may indeed present what is frequently feared to be

“The Global Enforcement Challenge”.230


1)          Third Party Enforcement
Recall231 how the term enforcement is used in this paper. As opposed to

compliance (or self-enforcement)232 enforcement as used herein means third-

party enforcement. At one point or another a third party, an external institution

comes in with the power to ultimately coerce the party in default to compliant

behavior.233 It includes what is sometimes referred to as contract or second-party

enforcement, since this also requires involvement of an external authority (courts,

enforcement authorities) at some point. As has been pointed out above,234 the

difference in state enforcement and contract enforcement lies only in the actor

initiating the enforcement process.


The following section will analyze whether and to what extent traditional

enforcement mechanisms in each of the four control systems involving external

enforcement           (state      enforcement,      contract     enforcement,      organization

enforcement, informal enforcement of social norms) can still provide for effective



230
   See ACCC, Enforcement Challenge, supra note 28. See also FTC, First Five Years, supra
note 106, at 22 (“Cross border fraud is harder to discover and stop, redress for consumers is
more difficult to achieve, ....”).
231
      See supra note 215 and accompanying text.
232
      See infra note 484 and accompanying text.
233
      See supra note 194 and accompanying text.
234
      See supra II.B.2).

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                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


enforcement of consumer rights in the online environment. How can and do

these mechanisms—that worked more or less well in the offline world—respond

to the “global enforcement challenge” as it has just been described? The answer

to this question will also tell us, whether consumers can still comfortably rely on

these mechanisms to “fix things if they go wrong”235 and ultimately whether they

will (unless they trust the merchant)236 enter into potentially risky distance

transactions at all.


a)           State Enforcement

In market economies whose legal systems generally respect—or are, in fact,

partly built on—the principles of consumer sovereignty237 or freedom of

contract238 it is all but obvious to speak of state (initiated) enforcement in regard

to individual consumers’ rights. The decision whether to enter into a contract and

under which terms and conditions is generally left completely to the transacting




235
      See supra note 143 and accompanying text.
236
      See infra II.D.
237
    See generally Cass R. Sunstein, From Consumer Sovereignty to Cost-Benefit Analysis: An
Incompletely Theorized Agreement?, 23 HARV. J.L. & PUB. POL’Y 203 (1999); W. Kip Viscusi,
Using Warnings to Extend the Boundaries of Consumer Sovereignty, 23 HARV. J.L. & PUB. POL’Y
211 (1999); Neil W. Averitt & Robert H. Lande, Consumer Sovereignty: A Unified Theory of
Antitrust and Consumer Protection Law, 65 ANTITRUST L.J. 713 (1997) (all discussing consumer
sovereignty and whether, on what grounds, and to what extent government interference and
intervention with consumer choice is legitimate). See also Iain Ramsay, Consumer Protection, in
1 THE NEW PALGRAVE, supra note 149, at 410, 411 (tracing the concept of consumer sovereignty
to W ILLIAM HAROLD HUTT, ECONOMISTS AND THE PUBLIC 257-99 (1936) who argued for the concept
on the grounds of liberty of choice and toleration of a variety of individual tastes, however
irrational these might be).
238
   The principle of private autonomy (“Privatautonomie”) and the principle of freedom of contract
(“Vertragsfreiheit”) that derives from it are the fundamental basics underlying German private law.
The German federal constitutional court (Bundesverfassungsgericht) has frequently emphasized
that these principles are protected under art. 2(1) of the German Constitution (Grundgesetz), see
72 BVerfGE 155, 170; 8 BVerfGE 274, 328.

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                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


individuals. The same typically holds true for the decision whether (or when) to

pursue enforcement of contractual rights or remedies when the other party does

not live up to the agreement. And indeed, it would strike us not only as extremely

impractical but also as unduly paternalistic239 if governments stepped in to bring

enforcement actions on behalf of a contractor every time a contract was

breached. A contractor might choose not to bring such an action at all or not to

bring it at this time for a variety of reasons (or for no reasons at all) and in

principle one would expect the government not to interfere with this decision.


The principle of consumer sovereignty, however, is not a dogma precluding

government involvement altogether. In fact, the preservation of consumer

sovereignty might compel governments to step in at one point or another.240 It is

generally recognized that especially in the event of a “market failure” government

interference is, to a certain extent, legitimate.241 Expressed somewhat simplified

a market failure exists either when one party to a transaction is extraordinarily

strong—legitimizing government interference in the form of antitrust regulation—

or when one party is extraordinarily weak—legitimizing government interference




239
   Cf. Ramsay, supra note 237, at 411 (“Consumer sovereignty is both an economic concept and
a political slogan that is frequently contrasted with the paternalism of a ‘nanny state’, that restricts
or channels choices.”).
240
    See id. at 410 (“The normative goal of consumer sovereignty is the central economic rationale
for consumer protection.”). See also BVerfG, 1994 NEUE JURISTISCHE W OCHENSCHRIFT [NJW] 36,
38 (arguing that the principle of private autonomy, because it protects both partners to a contract,
may indeed demand restrictions of the parties’ freedom of contract in cases of structurally
unequal bargaining power).
241
   See, e.g., Timothy J. Muris, Economics and Consumer Protection, 60 ANTITRUST L.J. 103, 104
(1991) (“The concept of market failure can be used to support a quite conservative or quite
activist consumer protection policy, depending on your bent.”);

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                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


in the form of consumer protection regulation.242 The latter can be a result of

information failure, structurally unequal bargaining power, or the existence of

(mostly economic) barriers to exercise existing rights.243


The two former of the above account for the enactment of laws aiming to protect

consumers from unbalanced and unfair contracts.244 These laws frequently

require the merchant to provide the consumer with specific information prior to

the formation of the contract.245 They often afford a consumer the right to return

the goods or to cancel or withdraw from the contract within a certain time

period.246 Sometimes they allow a judicial review regarding enforceability of




242
   See also Averitt & Lande, supra note 237 (characterizing consumer sovereignty as the
“overarching unity” that connects antitrust regulation and consumer protection law). The third
important basis for government interference is the protection of public policies.
243
      See Ramsey, supra note 237, at 410.
244
   See, e.g., Fred H. Miller, Consumers and the Code: The Search for the Proper Formula, 75
W ASH. U. L.Q. 187 (1997) (discussing consumer protection in the Uniform Commercial Code);
William S. Mayfield, Consumer Protection, 13 S.U. L. REV. 279 (1987) (analyzing a number of
consumer protection laws); Andreas P. Reindl, Consumer Contracts and European Community
Law, 75 W ASH. U. L.Q. 627 (1997) (giving an overview on the comprehensive activity of the
European Union regarding consumer protection regulation).
245
   See, e.g., Council Directive 85/577/EEC of 20 December 1985 to Protect the Consumer in
Respect of Contracts Negotiated Away from Business Premises, 1985 O.J. (L 372) 31; Council
Directive 87/102/EEC of 22 December 1986 for the Approximation of the Laws, Regulations and
Administrative Provisions of the Member States Concerning Consumer Credit, 1987 O.J. (L 42)
48, as amended by Council Directive 90/88/EEC of 22 February 1990, 1990 O.J. (L 61) 14, and
Directive 98/7/EC of the European Parliament and the Council of 16 February 1998, 1998 O.J. (L
101) 17; Distance Contracts Directive, supra note 24. See also Pichler, supra note 24, at II.C.
246
   See id. See also FTC Rule Concerning Cooling-Off Period for Sales Made at Homes or at
Certain Other Locations, 16 C.F.R. § 429.1 (1999) (giving consumers a right to cancel door-to-
door sales within three business dates and requiring merchants to furnish the consumer with
respective notice). See also Mayfield, supra note 244, at 287-88 (referring the FTC’s door-to-door
sales regulation).

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                         The Online-Marketplace: Shaking the Foundations of Consumer Confidence


certain provisions in contracts, particularly of terms and conditions in standard

form agreements.247


The latter of the reasons stated above that can lead to a consumer’s structural

inferiority in a transaction—the existence of (mostly economic) barriers to

exercise existing rights248 (including the rights especially granted in the consumer

protection laws just described)—leads to an issue that is particularly interesting in

our context: state enforcement of consumer protection laws. In this regard one

can observe an interesting difference between the United States, where the

enforcement of consumer protection laws to a large extent falls within the

competence of the Federal Trade Commission (FTC) and the Attorneys

General,249 and Europe, where the enforcement of her rights is mostly left to the

individual consumer.250 Finally the role of criminal proceedings in this context will

be addressed.251


aa)         The Federal Trade Commission and the Attorneys General

In the U.S. the FTC and the Attorneys General act as consumer protection

agencies.252 Although expressly acknowledging the AG’s role in enforcing




247
   See, e.g., Council Directive 93/13/EEC on Unfair Terms in Consumer Contracts, 1993 O.J. (L
95) 29.
248
      The problem of consumer access to justice will be discussed in detail infra II.C.1)b).
249
      See infra II.C.1)a)aa).
250
      See infra II.C.1)a)bb).
251
      See id.
252
   For an account of important differences between the two see Muris, supra note 241, at 106
(noting that the FTC has considerably more resources and that the AG’s are elected, leading to a
                                              60
                           The Online-Marketplace: Shaking the Foundations of Consumer Confidence


consumer’s rights with regard to online commerce,253 the following remarks will

focus primarily on the FTC. According to the Federal Trade Commission Act254

the FTC “is empowered and directed to prevent persons, partnerships, or

corporations ... from using unfair methods of competition in or affecting

commerce and unfair or deceptive acts or practices in or affecting commerce.”255

It has special investigative powers,256 as well the authority to initiate an

enforcement action if it finds “reason to believe” that the law is being violated.257


“The law” enforced by the FTC is primarily the prohibition of “unfair and deceptive

acts or practices”.258 Besides that the Commission enforces a number of other

consumer protection statutes that refer to its enforcement power under the FTC

Act,259 including the Truth-in-Lending Act260 and the Telemarketing and

Consumer Fraud and Abuse Prevention Act.261 Note, however, that the

Commission’s enforcement authority clearly primarily exists in the interest of the



tendency that the states use simple theories and seek highly visible cases, in addition to being
more reluctant to expensive litigation).
253
   In fact, issues related to consumer protection in cyberspace draw increasing attention of the
AG’s. Stanford University, for example, was host to the National Association of Attorneys General
conference on "The Impact of the Internet on the Mission of the Attorneys General” (Jan. 10-11,
2000).
254
      15 U.S.C. §§ 41-58 (1999).
255
      Id. § 45(a)(2).
256
      Id. §§ 46, 49.
257
   See generally Federal Trade Commission, A Brief Overview of the Federal Trade
Commission’s Investigative and Law Enforcement Authority (April 1998) [hereinafter FTC,
Overview] <http://www.ftc.gov/ogc/brfovrvw.htm>.
258
      15 U.S.C. § 45(1).
259
   For a complete overview see Federal Trade Commission, Statutes Enforced or Administered
by the Commission (last modified July 15, 1999) <http://www.ftc.gov/ogc/stats.htm>.
260
      15 U.S.C. §§ 1601-1667f (1999).

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                           The Online-Marketplace: Shaking the Foundations of Consumer Confidence


general public as such—or collective interests262—rather than in the interest of

individual consumers. This explains why the enforcement authority is limited to

acts or practices that “[cause] or [are] likely to cause substantial injury to

consumers which is not reasonably avoidable by consumers themselves ....”263 In

determining unfairness of an act or practice, the Commission is expressly entitled

to consider “established public policies”. 264 This focus on collective rather than

individual interests should be kept in mind when assessing the consequences of

FTC enforcement on consumer reliance below.265


The Commission can use a number of different enforcement mechanisms. In the

administrative process the Commission, if it has reason to believe that an unfair

or deceptive act or practice has been used, issues a complaint stating its charges

and serves it upon the alleged offender.266 The respondent may settle the

charges by consenting or contest them. The latter leads to a hearing and

ultimately to a final decision and order by the commission.267 The final order is

subject to review by a court of appeals and, eventually, by the Supreme Court.268




261
      15 U.S.C. §§ 6101-6108 (1999).
262
   This is a term which we will encounter again in the context the European Union’s attempts to
enhance judicial control of consumer protection laws. See infra II.C.1)b)bb)a .
263
      15 U.S.C. § 45(n) (emphasis added).
264
   Id. See also id. § 45(b) (“and if it shall appear to the Commission that a proceeding by it in
respect thereof would be to the interest of the public”) (emphasis added).
265
      See infra II.C.1)a)aa)b EE .
266
      15 U.S.C. § 45(b).
267
      See id. See also FTC, Overview, supra note 257.
268
      See U.S.C. § 45(c).

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                          The Online-Marketplace: Shaking the Foundations of Consumer Confidence


If an order has become final269 a separate suit to enforce it (by obtaining civil

penalties) needs to be brought in a federal district court in the event of a violation

of the order by the respondent.270 In addition to this—and of great relevance in

our context—the Commission can seek consumer redress in a federal district

court.271 The court in such an action may “grant such relief as [it] finds necessary

to redress injury to consumers ... resulting from the rule violation or the unfair or

deceptive act or practice, .... Such relief may include ... rescission or formation of

contracts, the refund of money or return of property, the payment of damages

....”272 Thus, the FTC Act actually does provide for a form of state enforcement

that may ultimately lead to compensation of individual consumers who became

victims of merchant fraud.273 In this it departs from the traditional understanding

of state enforcement where payments by the violator, such as criminal sanctions

or civil penalties, went to the state (i.e. to the public as a whole) instead of

individual victims (who normally would have had to bring their own civil action

when seeking redress). As indicated above,274 this is also an attempt to address




269
      For details see id. § 45(g).
270
     Id. 45(l). The penalty is up to $10,000 for each violation. Section § 45(m) also allows the
Commission to bring enforcement actions against any other person (i.e. not the addressee of the
initial order) who violates a Commission rule or order “with actual knowledge”, prove of which
normally requires that the Commission provided the violator with a copy of the order in question.
See FTC, Overview, supra note 257.
271
   See 15 U.S.C. § 57b(a)(2). If the action is brought against an act or practice to which the
Commission’s cease and desist order relates (as opposed to the violation of a Commission rule)
the Commission has to prove, that the act or practice is one “which a reasonable man would have
known under the circumstances was dishonest or fraudulent”.
272
      See id. § 57b(b).
273
      See supra note 248 and accompanying text.
274
    See supra note 248 and accompanying text. See also Muris, supra note 241, at 105 (“The
traditional government method for enforcing those rules has been the courts. As is well known,
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                             The Online-Marketplace: Shaking the Foundations of Consumer Confidence


the problem of economic barriers for consumers to actually exercise existing

rights—the problem of consumer access to justice.275


Instead of issuing cease and desist orders in specific cases, the FTC Act also

empowers the Commission to prescribe trade rules “which define in specificity

acts or practices which are unfair or deceptive”. 276 Rules the Commission has

prescribed under this authority include, for example, the “Rule Concerning

Cooling-Off Period for Sales Made at Homes or at Certain Other Locations”277 or

the “Mail Order Telephone Order Merchandise” Rule.278 The enforcement in the

event of a rule violation is parallel to the enforcement of cease and desist orders

as just described. The Commission may recover civil penalties up to $ 10,000 for

each violation279 by bringing an action in a federal district court.280 Furthermore,

the Commission can bring a suit for consumer redress.281


However, enforcement under both these procedures is an often lengthy multiple

step process. Therefore it is not surprising that another procedure, added to the



however, for consumer transactions going to court is usually not economically feasible. .... Thus,
government consumer protection agencies have become part of the process to enforce the basic
rules ....”).
275
      See infra II.C.1)b).
276
      See 15 U.S.C. § 57a(1)(B).
277
      See supra note 246.
278
   See 16 C.F.R. § 435 (1999). A complete listing of the FTC’s rules on commercial practices in
16         C.F.R.         Ch.          I         is         available       online           at
<http://www.access.gpo.gov/nara/cfr/waisidx_99/16cfrv1_99.html>.
279
   Under the condition that the unfair or deceptive act or practice was undertaken “with actual
knowledge or knowledge fairly implied on the basis of objective circumstances that such act is
unfair or deceptive and is prohibited by such rule.”
280
      See 15 U.S.C. § 45(m)(1)(A).
281
      See 15 U.S.C. § 57b(a)(1), (b).
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                           The Online-Marketplace: Shaking the Foundations of Consumer Confidence


FTC Act in 1973,282 became the “foundation of the Commission’s consumer fraud

program.”283 The added Section 13(b) of the FTC Act284 empowers the

Commission, if such action would be in the interest of the public,285 to seek

preliminary injunctions in a federal district court to enjoin any act or practice that

violates or is about to violate any provision of law enforced by the FTC.286 In

addition to these preliminary injunctions, which require the Commission to file a

complaint within a period not exceeding 20 days, “in proper cases the

Commission may seek, and after proper proof, the court may issue, a permanent

injunction.”287 Since the early 1980’s the Commission increasingly used

permanent injunctions in its consumer protection program.288 Going beyond the

literary text of Section 13(b), the Commission has, in addition to permanently

barring deceptive practices, also relied on this provision to obtain a freeze of

assets or imposition of temporary receivers, monetary damages, and consumer

redress in the form of rescission of contracts and restitution.289 The courts have




282
  The Section was added as part of the Trans-Alaska Pipeline Authorization Act of 1973, Pub. L.
No. 93-153, 87 Stat. 576. See Muris, supra note 241, at 108 n.7.
283
   Muris, supra note 241, at 108. Note that the term “consumer fraud” is used in the opposite
sense as it is used in this paper, see supra note 50 (explaining the different uses of the term).
284
      15 U.S.C. § 53(b).
285
      See 15 U.S.C. § 53(b)(2).
286
      See 15 U.S.C. § 53(b)(1).
287
      15 U.S.C. § 53(b) (emphasis added).
288
      See FTC, Overview, supra note 257.
289
    See id. See also Muris, supra note 241, at 108 n.12 (citing FTC v. Atlantex Assocs., 1987-2
Trade Cas. (CCH) ¶ 67,788 (S.D. Fla. 1987), aff’d, 872 F.2d 966 (11th Cir. 1989) (ordering $12
million in consumer redress), among other cases); FTC, First Five Years, supra note 106, at 8-9
(giving a short description of the FTC’s enforcement actions under Section 13(b) of the FTC Act).

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                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


accepted this construction of the Section by the Commission.290 Making use of

permanent injunctions and seeking redress under this procedure has many

advantages over traditional administrative action in the form of cease and desist

orders. It is namely faster and becomes effective immediately, and the

Commission can seek prohibitory and monetary relief in one single step. Thus,

“most consumer protection enforcement is now conducted directly in court under

Section 13(b), rather than by means of administrative adjudication.”291 In our

context it is worthy to repeat that Section 13(b) has successfully (i.e. with

approval of the courts) been construed by the Commission as to including an

authorization to seek consumer redress in addition to stopping the unfair or

deceptive conduct.


α)          Enforcement Efforts Regarding Electronic Commerce

As of December 15, 1999 the FTC has brought more than 100 enforcement

actions involving the Internet and online services.292 Since the very beginning it

has been the Commission’s declared policy that consumer protection principles

be applied in the electronic marketplace no less than they are offline.293 But the

FTC has also taken new approaches to take on the challenges for consumer



290
      See id.
291
   See FTC, Overview, supra note 257. See also Muris, supra note 241, at 109 n.14 (explaining
the lengthy process of first obtaining a final cease and desist order and then bringing a separate
proceeding under 15 U.S.C. § 57b(a)(2) seeking consumer redress).
292
      See FTC, Cases, supra note 125.
293
    See Federal Trade Commission, Staff Report, Anticipating the 21st Century: Consumer
Protection Policy in the New High-Tech, Global Marketplace 46 (May 1996)
<http://www.ftc.gov/opp/global/report/gc_v2.pdf> [hereinafter FTC, Anticipating the 21st Century].


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                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


protection presented by the new and rapidly changing online environment.294

Believing that to some extent “the answer to the machine is in the machine”295

the Commission established “Consumer Sentinel”, a database containing

consumer fraud complaints—contributed by consumers,296 law enforcement

agencies, or consumer organizations like the Better Business Bureau. The data

can be retrieved by various law enforcement agencies in the U.S. and Canada.297

This initiative tries to address the problem of sharing a lot of information very fast,

which is crucial to fight frequently transient298 Internet fraud schemes. Since

learning of fraudulent online practices is not enough, the Commission also

created an Internet Fraud Rapid Response Team, that puts particular matters on

a fast track for enforcement.299 The Commission further established an Internet




Other policy goals included avoiding undue burdens on business and technology, encouraging
effective self-regulation, and fostering co-operation between the public and the private sector.
294
     See generally FTC, The Challenge and the Campaign, supra note 50; FTC, New Tools of the
Trade, supra note 50; FTC, First Five Years, supra note 106 (all describing the challenges faced
and the new approaches taken by the Commission to address them). See also W ORKING GROUP
II, supra note 4, at 18-20 (describing the FTC’s and other agencies’ efforts).
295
   See generally Charles Clark, The Answer to the Machine is in the Machine, in THE FUTURE OF
COPYRIGHT IN A DIGITAL ENVIRONMENT 139 (P. Bernt Hugenholtz ed., 1996) (coining this
expression in regard to law enforcement and cyberspace).
296
    Via the FTC’s tell-free telephone number, or by using the online complaint form. See Federal
Trade Commission, Bureau of Consumer Protection, Complaint Form (last modified Feb. 18,
2000) <https://www.ftc.gov/ftc/complaint.htm>. See also FindLaw Legal News, U.S. launches
Internet          fraud          complaint        center           (May          8,       2000)
<http://news.findlaw.com/legalnews/s/20000508/N0848641.html> (quoting Attorney General
Janet Reno: "It will be a one-stop shopping approach to identifying Internet fraud schemes and
referring them to the proper law enforcement agencies.").
297
      See FTC, First Five Years, supra note 106, at 4-5.
298
      See supra note 224 and accompanying text.
299
   See FTC, First Five Years, supra note 106, at 5 (citing FTC v. Benoit, No. 3:99 CV 181
(W.D.N.C. filed May 11, 1999), a case in which an injunction stopping the deceptive conduct was
reached within three weeks of learning about it).

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                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


Lab providing the necessary state-of-the-art equipment and developing the

necessary expertise to effectively investigate online.300


It further introduced so called “Surf Days”, a combined and concentrated effort by

several law enforcement agencies focusing on identifying specific online

scams.301 The identification of questionable conduct is followed by a warning to

the site operators, in response to which many of whom improve or remove their

sites,302 a follow-up visit, and eventually enforcement action if the site operator

has not responded.


In addition to enforcement the FTC emphasizes business and consumer

education, disseminating information over the web and thus making use of the

“target-rich environment”303 for its own purposes this time.304 Another tool

employed by the Commission is the “teaser” website.305 These sites are

designed to mimic fraudulent sites and are indexed in a way that they are as

likely to be found by search engines as their “original” counterparts. After leading

the user through several steps, the FTC seal appears and warns the user that



300
      See id.
301
    See id. at 6; FTC, New Tools for the Trade, supra note 50, at 12. The Commission’s efforts
included a Credit Repair Surf Day, a Business Opportunities Surf Day, a Scholar Scam Surf Day,
a Coupon-related Business Opportunity Surf Day, an International Health Claims Surf Day, a
HUD Tracers Surf Day, an International Surf Day, a Health Claims Surf Day, a Pyramids Surf
Day, a Business and Investment Opportunities Surf Day, and Junk Email Surf Day. See FTC,
New Tools for the Trade, supra note 50, at 13-14; FTC, First Five Years, supra note 106, at 6.
302
   Although there seems to be no control as to how many of them just redesign their sites. See
supra note 115 and accompanying text regarding the problem of redesigning and “reopening”
fraudulent sites.
303
      See supra note 228.
304
      See FTC, First Five Years, supra note 106, at 16.

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                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


offers like this one are often fraudulent. The idea behind it basically is to reach

consumers before fraudsters do and to raise their awareness.306 The educational

efforts finally include partnerships with reputable and popular online services and

other entities that link to FTC information, and consumer.gov,307 an easy to

understand site featuring tips and information for consumers.308


These efforts by the Federal Trade Commission and other enforcement agencies

are certainly very valuable and without doubt they play a significant role in

reducing online fraud. Just how significant that role is, however, remains unclear.

The next section will discuss the obvious limits of state enforcement in the

context of online commerce and their implications for consumer reliance on this

kind of enforcement.


β)          The Limits of State Enforcement and Their Implications for Consumer
            Reliance

An increased effort by the FTC and other state enforcement agencies to enforce

consumer protection laws in cyberspace will likely make the Internet a safer, but

almost certainly not a safe place for consumers. As in other areas,309



305
      See id.
306
      See FTC, New Tools of the Trade, supra note 50, at 18.
307
      See <http://www.consumer.gov>.
308
      See FTC, First Five Years, supra note 106, at 17.
309
     Despite increased enforcement efforts, for example, against telemarketing fraud—the
Telemarketing and Consumer Fraud and Abuse Prevention Act, supra note 261, was passed by
Congress in 1994 as Pub. L. No. 103-297 and as directed in the Act the FTC promulgated the
Telemarketing Sales Rule, 16 C.F.R. § 310 (1999), effective Dec. 31, 1995—telemarketing fraud
itself evolved with it, see FTC, The Challenge and the Campaign, supra note 50, Executive
Summary.

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                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


enforcement won’t be perfect. And even more than in other areas, there will be a

constant race between new, more sophisticated, and harder to detect online

scams and improved law enforcement. As mentioned before, the Internet

provides enormous opportunities for fraudsters.310 These are combined with

chances of escaping detection that are greater than ever.311 To this background it

appears fair to assume that Internet fraud is here to stay—and grow.


αα)         Limited Enforcement

Recall some of the major challenges for law enforcement in this new environment

that have been identified earlier: anonymity, mobility and globality.312 The first

two make it hard to detect and trace fraudsters. “[M]astering the technology and

finding the perpetrators in cyberspace” is concededly a significant problem faced

by the FTC and other law enforcement agencies.313 The fact that, while fraud is

increasing, “government resources at all levels are shrinking”,314 presents an

additional problem. To be sure, law enforcement agencies will also make use of

the newest technology, they will develop considerable expertise,315 and they will



310
      See supra notes 114 and text accompanying notes 228-229.
311
      See supra II.C.
312
      For a general overview see supra II.C.
313
   See FTC, New Tools of the Trade, supra note 50, at 5. See also FTC, The Challenge and the
Campaign, supra note 50, Challenges for Law Enforcement (“The increase in high-tech and
global marketing scams is especially troublesome.”); FTC, Anticipating the 21st Century, supra
note 293, at 4 (“For law enforcement agencies, the emerging technologies present serious
challenges in detection, apprehension, and enforcement. With a telephone or an online link,
fraudulent marketers can set up shop quickly and cheaply, and move on without a trace. ... For
the cyber scam artist, it may be even easier [than for the fraudulent telemarketer] to escape
detection.”).
314
      See FTC, Anticipating the 21st Century, supra note 293, at 5.
315
      See supra note 300 (referring to the FTC’s Internet Lab).
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                         The Online-Marketplace: Shaking the Foundations of Consumer Confidence


increasingly co-operate with Secret Service, other government agencies, and the

private sector to detect and trace online fraud.316 On the other hand it is obvious,

that the fraudsters’ expertise in concealing their identity and location and

avoiding detection will increase as well.317 Moreover, legitimate privacy

interests318 of honest users will establish yet other boundaries for the

investigative powers of law enforcement agencies.319


Put these problems of tracing a fraudster aside for a moment, and take one step

back: Thinking about how to trace a fraudster presupposes that the enforcement

agency knows about the fraud in the first place. The sheer magnitude of online

communication suggests that a significant number of fraudulent communications

will remain undetected. The “Surf Days”320 established by the FTC would not help

to detect fraudulent schemes that are not apparent from the website itself. In

particular they won’t allow detection of merchants that take orders (and money)

but never send the goods to the consumer. Detecting those scams would require

test orders, a process that may be lengthy and cannot feasibly be done on a

large scale. Thus, enforcement agencies depend on consumers’ reporting a



316
   See FTC, New Tools of the Trade, supra note 50, at 5 (citing FTC v. Audiotex Connection,
Inc., CV-97-0726 (E.D.N.Y. filed Feb. 13, 1997) and describing how co-operation with AT&T and
Secret Service helped to find the scammers and their assets).
317
      See supra note 223.
318
      Including a legitimate interest in anonymity, see, e.g., Rothchild, supra note 31, at 928.
319
   The conflict of legitimate interests in privacy with the interests of law enforcement agencies
have been discussed intensively, in particular to the background of the U.S. encryption policy.
See also Jake Kirchner, Forget having privacy on the Net, ZDNet News (March 22, 2000)
<http://www.zdnet.com/zdnn/stories/comment/0,5859,2472006,00.html> (citing cases giving
“scary” evidence “of a rush by police, judges, and legislators to take advantage of new
technologies with little or no thought to the privacy issues involved).


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                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


fraud. Given the fact, however, that an overwhelming number of consumers

never report being defrauded,321 this is a highly unsatisfactory basis for detecting

fraudulent practices of online merchants.


Finally, even when law enforcement agencies learned of a fraudulent practice

and were able to trace the perpetrator, they may—and in the online context they

will increasingly—face jurisdictional limits.322 As a general principle of

international law, a sovereign’s (or its agencies’) jurisdiction to enforce323 is

strictly limited to its own territory to the extent that a state’s authorities cannot

directly exercise physical power in another state’s territory without that state’s

consent.324 Accordingly, Section 3 of the FTC act expressly states that “[t]he



320
      See supra note 301 and accompanying text.
321
     See FTC, The Challenge and the Campaign, supra note 50, n.23 and accompanying text
(citing the FTC’s Project Roadblock, revealing that less than five percent of consumers affected
by deceptive practices reported their losses). See also Committee on Government Operations,
The Scourge of Telemarketing Fraud: What Can Be Done Against it?, Fifteenth Report by the
Committee on Government Operations (U.S. G.P.O.: 1991), p.2 (estimating that less than one-
tenth of consumer victims of telemarketing fraud ever report their victimization).
322
   See also Heckman, supra note 113, at 2.4 (“Even if law enforcement can identify and locate a
fraudulent supplier, successful apprehension and prosecution will often depend on co-operation
from multiple jurisdictions.”).
323
     See generally RESTATEMENT (THIRD) OF FOREIGN RELATIONS LAW § 401 (1986) (The
Restatement distinguishes between jurisdiction to prescribe, jurisdiction to adjudicate, and
jurisdiction to enforce as follows: “Under international law a state is subject to limitations on (a)
jurisdiction to prescribe, i.e., to make its law applicable to the activities, relations, or status of
persons, or the interests of persons in things, whether by legislation, by executive act or order, by
administrative rule or regulation, or by determination of a court; (b) jurisdiction to adjudicate, i.e.,
to subject persons or things to the process of its courts or administrative tribunals, whether in civil
or in criminal proceedings, whether or not the state is a party to the proceedings; (c) jurisdiction to
enforce, i.e., to induce or compel compliance or to punish noncompliance with its laws or
regulations, whether through the courts or by use of executive, administrative, police, or other
nonjudicial action.”).
324
    The prohibition of exercising physical power within the territory of another sovereign is a long
standing and undisputed principle of the law of nations. See, e.g., S.S. Lotus (Fr. v. Turk.), 1927
P.C.I.J. (ser. A) No. 10, at 18-19 (Sept. 7) (“Now the first and foremost restriction imposed by
international law upon a State is that—failing the existence of a permissive rule to the contrary—it
may not exercise its power in any form in the territory of another State. In this sense jurisdiction is
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                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


commission may prosecute ... any inquiry necessary to its duties in any part of

the United States.”325 To be sure, a state is not generally barred from ordering

enforcement measures against foreigners.326 Thus, a court or an administrative

agency—if it has the respective competence under domestic law—could in

principle impose civil or criminal sanctions or penalties, order a person to refrain

from doing specific acts, or order a freeze of assets327 pertaining to persons (or

assets) located outside its territory. But actual enforcement of these orders would

always require recognition of the measures and cooperation by the respective

foreign state. Moreover, it is dubious whether the FTC could even initiate the

respective orders in the first place, since the FTC Act expressly limits its authority

to inquiries in any part of the United States.328




certainly territorial; it cannot be exercised by a State outside its territory except by virtue of a
permissive rule derived from international custom or from a convention.”).
Jurisdiction to prescribe and jurisdiction to adjudicate are not in the same sense strictly territorial,
since they may also be exercised in regard to conduct that takes place in a foreign country but
has certain effects within the U.S. See generally Rothchild, supra note 31, at 912-915 (discussing
jurisdiction to prescribe and to adjudicate in the online context).
325
      15 U.S.C. § 43 (1999) (emphasis added).
326
    In this regard the term “jurisdiction to enforce” as used in the RESTATEMENT (THIRD) OF
FOREIGN RELATIONS LAW § 431 (1986) is broader than the prohibited exercise of a state’s power in
any form in the territory of another State. According to Section 431(3) “A state may employ
enforcement measures against a person located outside its territory (a) if the person is given
notice of the claims or charges against him that is reasonable in the circumstances; (b) if the
person is given an opportunity to be heard, ordinarily in advance of enforcement, whether in
person or by counsel or other representative; and (c) when enforcement is through the courts, if
the state has jurisdiction to adjudicate.”
327
    See, e.g., Hong Kong and Shanghai Banking Corporation v. Simon, 153 F.3d 991, 996 (9th
Cir. 1998) (freeze of assets not located in jurisdiction in bankruptcy proceedings).
328
   See supra note 325. According to RESTATEMENT (THIRD) OF FOREIGN RELATIONS LAW § 431(1)
(1986) “A state may employ judicial or nonjudicial measures to induce or compel compliance or
punish noncompliance with its laws or regulations, provided it has jurisdiction to prescribe in
accordance with ss 402 and 403.” And although Congress generally has the power to extend the
scope of legislation extraterritorially when a sufficient connection to the U.S. exists, “[i]t is a long-
standing principle of American law ‘that legislation of Congress, unless a contrary intent appears,
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                      The Online-Marketplace: Shaking the Foundations of Consumer Confidence


To this background it is not surprising that the FTC itself sees globalization and

“cross-border fraud” as the major challenges in the online arena.329 As described

above, actual enforcement in a foreign country always requires cooperation of

the respective authorities in that state.330 While this might work out well in some

cases,331 it probably will not in others,332 and it will almost always be more time

consuming.


In sum, state enforcement faces considerable obstacles in the online

environment. It will constantly have to try to catch up with perpetrators, and it will

never be able to completely overcome the problems posed by anonymity,

mobility, and globality—the three main characteristics that are inherent to

cyberspace and that are so advantageous to online fraudsters.




is meant to apply only within the territorial jurisdiction of the United States.’” See EEOC v. Arabic
American Oil Co., 499 U.S. 244, 248 (1991) (quoting Foley Bros. v. Filardo, 336 U.S. 281, 285
(1949)). The language in the FTC Act (“in any part of the United States”), however, strongly
indicates that the Act was not meant to be applied extraterritorially.
329
   See FTC, First Five Years, supra note 106, at 22; FTC, The Challenge and the Campaign,
supra note 50. See also supra note 230.
330
    See also ACCC, Enforcement Challenge, supra note 28, at 30, 36. There are also increased
efforts to cooperate with regard to the detection of online scams, see, e.g., Federal Trade
Commission, 150 Organizations in 28 Countries Tackle Internet Fraud (March 23, 2000)
<http://www.ftc.gov/opa/2000/03/rich.htm> (describing an international surf day as “the largest
ever international law enforcement project to fight fraud on the Internet”).
331
   See, e.g., FTC v. Carlos Pereira d/b/a atariz.com, No. 99-1367-A (E.D. Va filed Sept. 14,
1999) (involving close cooperation between the FTC and the Australian Competition and
Consumer Commission, see FTC, Cases, supra note 125, at 40). See also FTC, New Tools of
the Trade, supra note 50, at 16 (describing the “internic.com” case—see supra note 117—that
involved an Australian site operator and was ultimately referred by the FTC to the Australian
Competition and Consumer Commission, which is now investigating the case).
332
    In fact, there already seem to be some countries establishing themselves as a preferred base
for fraudulent activities aimed at “foreign” consumers.

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                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


ββ)         Limited Reliance

Those limits to state enforcement, the fact that it will always be far from perfect,

however, is just one reason why it will not really induce individual consumers to

confidently rely on it when deciding whether to enter in potentially risky online

transactions. Unless when trusting the merchant, the consumer will generally

enter into transactions only if she believes that things can be fixed if they go

wrong—if she can rely on an external institution to prevent her from incurring a

permanent loss. Besides necessarily being imperfect, i.e. not being able to

detect, trace, or bring enforcement actions against all fraudulent online

merchants, there are several other reasons why consumers are likely not to rely

on state enforcement—and in fact would be ill-advised to do so.


First, recall that state enforcement agencies primarily act in the interest of the

public as a whole, rather than in the interest of individual consumers. This

general principle is expressed in the FTC Act, which calls on the Commission to

issue a complaint in regard to unfair or deceptive acts or practices “if it shall

appear to the Commission that a proceeding by it in respect thereof would be to

the interest of the public”.333 It has also been mentioned before334 that the

Commission’s authority is limited to acts or practices that “[cause] or [are] likely

to cause substantial injury to consumers which is not reasonably avoidable by




333
    15 U.S.C. § 45(b) (emphasis added). See also supra note 264 and accompanying text.
Preliminary or permanent injunctions—the main enforcement procedure employed by the
Commission in consumer protection cases—will also only be granted if it “would be in the interest
of the public.” See 15 U.S.C. § 53(b)(2).
334
      See supra text accompanying note 263.

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                         The Online-Marketplace: Shaking the Foundations of Consumer Confidence


consumers themselves ....”335 This could, above all, have an impact on the

Commission’s allocation of resources, which are likely to be devoted to cases

affecting a large number of victims.336 Thus, the victim of a relatively “small” but

may be hard-to-detect scam, runs a great risk of being disappointed when relying

on the FTC to step in on her behalf. And consumers who become victims of

scams typically don’t know that in advance (i.e. when entering the transaction).

That means they neither know whether things will go wrong at all, nor do they

know for how many people they will if they do. Altogether this brings about a fair

degree of uncertainty whether state enforcement agencies, given the problem of

limited resources, will find that taking action in a particular case will be to the

overall interest of the public or not—and consumers virtually have no way to find

out in advance. And remember that this uncertainty exists in addition to the

uncertainties as to whether the Commission—even if it decided to bring an

enforcement action—will be able to identify the fraudster, track her, and find her

within its jurisdictional reach.


To be sure, although the FTC acts primarily in the public interest, it is empowered

to bring actions for consumer redress.337 In fact, without that possibility there

would be no basis for consumer reliance at all, since a civil penalty 338 and



335
      15 U.S.C. § 45(n) (emphasis added).
336
   See also supra note 252 (citing Muris arguing that State Attorney Generals, who are elected,
are likely to choose highly visible cases).
337
    See supra notes 271, 281, and 289 and accompanying text (describing the availability of
consumer redress under all enforcement procedures—cease and desist order, rule violation,
injunctions—available to the Commission).
338
      Just as a criminal sanction, see infra II.C.1)a)bb).

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stopping the fraudulent behavior for the future might protect potential future

victims, but does not fix things for the consumer for whom they already have

gone wrong. But the latter—the availability of recourse or redress if she doesn’t

get the goods and services she paid for—is, of course, an individual consumer’s

main concern when deciding whether to enter into a transaction or not. 339 So the

FTC’s power to seek consumer redress is a prerequisite to establishing any basis

for consumer reliance. Redress, however, is not available unless the

Commission detects the fraud, decides to take action, identifies the fraudster,

tracks her location, and has jurisdiction to bring enforcement action against

her.340 Thus, it is subject to the same limitations that have been discussed above.

In addition to these, there are at least two more obstacles specifically related to

consumer redress sought by the Commission. First, unless a fraudster keeps

perfect records, it might prove very difficult to identify all consumers victimized by

a specific fraudulent, unfair, or deceptive act. And given the phenomenon of

widespread underreporting,341 one cannot expect all victims to monitor FTC

actions or the respective public notices to learn about enforcement actions and

the possible availability of redress.342 Thus, the Commission might not know



339
      See supra notes 15, 144 and accompanying text.
340
   To be sure, the FTC does seek redress “for all injured consumers, no matter where they live”,
see FTC, First Five Years, supra note 106, at 23. This, however, only works when the perpetrator
can be found within the FTC’s jurisdiction. If that is not the case, the FTC might be unable to even
seek redress for consumers within the U.S.
341
      See supra note 321.
342
    See 15 U.S.C. § 57b(c)(2) (“The court shall cause notice of an action under this section [for
consumer redress] to be given in a manner which is reasonably calculated, under all of the
circumstances, to apprise the persons ... allegedly injured by the defendant’s rule violation or act
or practice of the pendency of such action. Such notice may, in the discretion of the court, be
given by publication.”).
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                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


about all victims, and the victims might not know about the FTC seeking redress

on their behalf. In both cases consumers won’t get redress after all. Also, the

Commission can’t guarantee that at the time redress is sought it will be able to

find sufficient assets to redress all the victims.343 In fact, sophisticated fraudsters

are likely to find ways to keep their profits out of law enforcement’s reach.


Finally, the FTC’s authority is limited to “unfair or deceptive acts or practices in or

affecting commerce”.344 This means that the FTC does not step in, when—

absent an actually deceptive or fraudulent act of the merchant—things “just go

wrong”, as they do from time to time in cross-border transactions.345 The fact that

it will not always be easy to tell, why goods in such transactions never arrived

(and the fact that it will be even harder to proof why they didn’t) adds to the

uncertainty as to whether state enforcement will eventually step in or not. Did the

goods not arrive because the merchant, as it has planned from the very

beginning, never sent them, or because they just got lost in transit? The former

could trigger FTC action, while the latter would not.


It is not the intention of this paper to belittle or even deny the importance of the

FTC’s actions in regard to protecting consumers online. There can hardly be any

doubt, that these actions reduce online fraud and make the online marketplace a




343
   For an example see FTC, New Tools of the Trade, supra note 50, at 11 (citing a case in which
the FTC filed suit against a perpetrator and obtained an asset freeze over $1.4 million—
defrauded consumers, however, spent a total of $9.5 million).
344
      15 U.S.C. § 45(a)(2) (emphasis added). See also supra text accompanying note 255.
345
   See supra note 122 and accompanying text. Heckman, supra note 113, at 2.4 calls this “more
innocent violations of consumer protection regulation.”

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                     The Online-Marketplace: Shaking the Foundations of Consumer Confidence


generally somewhat safer place for consumers. But there can also be no doubt,

that the Commission’s enforcement actions will stay far from eliminating online

fraud. The Commission and other state enforcement agencies will not be able to

detect all fraudulent actions, bring action even against all that are detected,

identify all persons behind them, track the physical location of those persons,

actually assert jurisdiction over them, or recover all losses incurred by

consumers. And, most importantly, it is impossible for an individual consumer to

tell ex ante whether she will ultimately get redress by state enforcement if things

go wrong in that one transaction she is or isn’t about to enter. One simply cannot

know in advance. Therefore state enforcement remains important, but it is next to

no basis for consumer reliance.


bb)      The European Approach and Criminal Proceedings

While the FTC acts primarily in the interest of the public in general, it may also

seek consumer redress under specific circumstances. When a merchant’s online

act or practice reaches the quality of a criminal offense, the merchant may also

face criminal enforcement actions. The remedies under criminal law generally

contain fines and penalties. It does not provide for redress for individual

consumers. It is, in fact, usually left to the victim to seek compensation in a

separate civil action for breach of contract or fraud.346




346
   See also Ellen M. Faro, Note, Telemarketing Credit Card Fraud: Is RICO one Answer?, 1990
U. ILL. L. REV. 675. Faro asserts that, regarding credit card fraud, the present criminal laws are
not an effective deterrent. She proposes to give victims more incentives to combat credit card
fraud by means of civil suits for damages that go beyond actions under theories of ordinary
common law fraud. She namely proposes to apply the Racketeer Influenced and Corrupt
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Thus, subject to and within the same limitations identified in regard to

enforcement by the FTC (difficulties to detect fraud, identify fraudsters, assert

jurisdiction over them, etc.),347 criminal enforcement may serve as a general

deterrent against deceptive or fraudulent online practices. But absent a possibility

to seek redress for individual consumers, it cannot serve as a basis for consumer

reliance, because criminal law simply can’t “fix things” for the consumer for whom

they have already gone wrong.


European countries have no equivalent to the FTC. Enforcement of consumer

protection laws or of consumer rights is generally left to the consumers who must

bring civil actions in the courts if they desire redress.348 The European

Commission itself rightly points out that “European Directives generally aim to

give (through their implementation) direct rights to consumers, which they can

invoke against enterprises and professionals. Any failure or difficulty in

guaranteeing access to justice to individual consumers automatically leads to




Organizations Act of 1970, Pub. L. No. 91-452, § 901(a), 84 Stat. 941 (codified at 18 U.S.C.
§§ 1961-68 (1999) [hereinafter RICO]), under which victims may bring a civil action in a United
States district court to recover treble damages and reasonable attorney’s fees (see 18 U.S.C. §
1964(c)).
For a discussion whether RICO, which was originally meant to combat organized crime, applies
to so called “garden variety” fraud see, for example, Faro, supra, at 686; Note, Civil RICO and
“Garden Variety” Fraud—A Suggested Analysis, 58 ST. JOHN’S L. REV. 93 (1983); Comment, Civil
RICO and Its Application to “Garden Variety” Fraud Within the Sixth Circuit, 13 N. KY. L. REV. 463
(1987); Comment, What Have They Done to Civil RICO: The Supreme Court Takes the
Racketeering Requirement Out of Racketeering, 35 AM. U. L. REV. 821 (1986).
347
      See supra II.C.1)a)aa)b DD .
348
      See also supra note 274.

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failures in the enforcement of European law at the national level.”349 Having

shown the limits of state enforcement, we will now turn to court enforcement (and

the problem of access to justice for individual consumers) to see whether it

provides a viable basis for consumer reliance in the context of electronic

commerce.


b)          Court Enforcement

Court enforcement typically refers to a civil action for breach of contract or fraud

brought by the consumer who did not get what she paid for or was defrauded in

another way.350 In addition to that there are some less traditional variations of

court enforcement like rights to sue for consumer organizations351 or class

actions. These alternatives will immediately be addressed in greater detail. One

problem, however, is common to all of these options as well as to state

enforcement. For practical reasons, a suit against a merchant can’t be brought if

that merchant can’t be identified nor located. In this respect court enforcement

faces the same problems (particularly anonymity and mobility) that have been

discussed above in the context of state enforcement. 352 When concealing its

identity and escaping detection it makes no difference for a fraudster whether

she is concealing it from or escaping a government agency or a defrauded




349
    See European Commission, Working Paper on Enforcement of European Consumer
Legislation            14            (visited           Aug.             17, 00)
<http://www.europa.eu.int/comm/dg24/policy/developments/enfo/enfo01_en.pdf >
350
      See infra II.C.1)b)aa).
351
      See infra II.C.1)b)bb).
352
      See supra II.C.1)a)aa)b DD .

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consumer. This already presents a significant limitation for court enforcement as

a basis for consumer reliance. But even when the potential defendant can be

identified and located, the possibility of court enforcement is unlikely to generate

significant consumer confidence in the fact that things can be fixed if they go

wrong—that it is safe to rely on the actual availability of redress to compensate

losses that have been incurred. The following sections will analyze this for the

different alternatives of court enforcement mentioned above.


aa)      Suits Brought by Individual Consumers

It is one thing that a consumer has the right to bring a suit against a merchant

who not fully complied with its obligations or engaged in fraudulent activities. It is

another thing, whether consumers will actually do so in practice—whether it

makes economic sense for a consumer to do so.


α)       Some Economics of Consumer Litigation

As a general rule,353 a rational plaintiff will bring suit if and only if the expected

judgment exceeds her expected litigation costs. The expected judgment is the




353
   On the economics of litigation see generally William M. Landes, An Economic Analysis of the
Courts, 14 J. LAW & ECON. 61 (1971); John P. Gould, The Economics of Legal Conflicts, 2 J.
LEGAL STUD. 279 (1973); Richard A. Posner, An Economic Approach to Legal Procedure and
Judicial Administration, 2 J. LEGAL STUD. 399 (1973); Steven Shavell, Suit, Settlement, and Trial:
A Theoretical Analysis Under Alternative Methods for the Allocation of Legal Costs, 11 J. LEGAL
STUD. 55 (1982) [hereinafter Shavell, Suit, Settlement, and Trial]; Steven Shavell, The Social
Versus The Private Incentive to Bring Suit in a Costly Legal System, 11 J. LEGAL STUD. 333
(1982) [hereinafter Shavell, Incentive to Bring Suit]; Robert D. Cooter & Daniel L. Rubinfeld,
Economic Analysis of Legal Disputes and Their Resolution, 27 J. ECON. LIT. 1067 (1989); Lucian
Arye Bebchuk, A New Theory Concerning the Credibility and Success of Threats to Sue, 25 J.
LEGAL STUD. 1 (1996); Lucian Arye Bebchuk & Howard F. Chang, An Analysis of Fee Shifting
Based on the Margin of Victory: On Frivolous Suits, Meritorious Suits, and the Role of Rule 11, 25
J. LEGAL STUD. 371 (1996). See also A. MITCHELL POLINSKY, AN INTRODUCTION TO LAW AND
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judgment in favor of the plaintiff when she wins the case multiplied by the

probability of winning.354 If the conditions are reversed, a rational plaintiff will not

sue. She would incur higher costs than she would benefit from her expected

judgment. Her net benefits would be negative; she would lose money. These so

called “negative-expected-value suits” are common in small-stakes cases 355 and

lead to a general problem of access to legal remedies when the plaintiff’s claim is

small in relation to the costs.356


αα)         Benefits

Due to the nature of business-to-consumer transactions, the stakes involved are

typically relatively low. In one survey of consumer purchases, for example, the

average value of goods involved in a transaction was about $40. 357 The overall

average of value per transaction is presumably even lower than that. So even

when the plaintiff’s probability of prevailing at trial were one, the expected

judgment would be quite low.358




ECONOMICS 107-18 (2d ed. 1989); RICHARD A. POSNER, ECONOMIC ANALYSIS OF LAW § 21.5, at
                            th
607-15; § 21.9, at 624-32 (5 ed. 1998).
354
   When p is the probability of the plaintiff winning, J the value of a winning judgment, and c the
costs then the plaintiff would sue if pJ > c.
355
      See Bebchuk, supra note 353, at 1-2. See also Cooter & Rubinfeld, supra 353, at 1089.
356
      See, e.g., Posner, supra note 353, at 438; POSNER, supra note 353, § 21.9, at 627.
357
      See Stiftung Warentest, supra note 131, at 24.
358
    In this value range, even treble damages under RICO (see supra note 346) would not
significantly change that fact.

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The probability of winning, however, generally is not one. It is, among other

things, influenced by the possibility of judicial error.359 Some authors have shown

a connection between the frequency of judicial error, the parties’ expenditures on

litigation and the stakes involved in the dispute. The resource inputs by the

plaintiff and the defendant raise or lower the probability of the plaintiff winning the

case, respectively360—at least to some extent.361 The resource inputs themselves

are influenced by the stakes. Higher stakes will induce the parties to spend more

money on litigation, which will in turn reduce the probability of judicial error.362

This suggest that the probability of winning tends to be lower363 when the

asserted claim is relatively small—as it typically is in the business-to-consumer

transactions discussed here. There are some other factors that influence the

probability of prevailing in court and that are particularly problematic in the

context of disputes resulting out of e-commerce transactions. Often the

consumer will lack information or documentation regarding the transaction and

the merchant’s conduct. Thus, although she clearly was defrauded, she might

have a hard time proving her case. Moreover, in an action for fraud, the plaintiff




359
   See A. Mitchell Polinsky & Steven Shavell, Legal Error, Litigation, and the Incentive to Obey
the Law, 5 J. L. ECON. & ORG. 99 (1989).
360
   See Landes, supra note 353, at 101. See also Gould, supra note 353, at 287 (describing the
decision as to the amount of resources each party will spend as a two-person game in which the
optimal expenditure of one litigant depends on the behavior of the other)
361
     See Posner, supra note 353, at 435 (suggesting a threshold above which the outcome of
litigation is possibly insensitive to variations in the parties’ expenditures).
362
      See id., at 404, 429-435, 441.
363
      While augmenting it by increased litigation expenditure faces the limits set by inequality (1).

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must comply with Rule 9(b) of the Federal Rules of Civil Procedure,364 requiring

that “[i]n all averments of fraud or mistake, the circumstances constituting fraud

or mistake shall be stated with particularity.”365 As construed by the courts in light

of Rules 8(a)(2),366 8(e)(1),367 and 8(f),368 “[i]n order to meet the requirements of

Rule 9(b), the complaint must identify the time, place, content, and maker of the

false representation.”369 These requirements have proven problematic in mail

and wire fraud cases,370 and the same danger obviously exists in the online

context.


Further, e-commerce transactions are often international.371 Cross-border

litigation frequently raises difficult choice of law issues. Courts and parties might

face the question whether clickwrap choice-of-law clauses are enforceable and

the preliminary question, which law governs the enforceability question. These

issues can have a substantial influence on the outcome of the case, since

different views prevail, for example, on the enforceability of warranty disclaimers



364
    See also Faro, supra note 346, at 689 (pointing to that problem in regard to wire fraud
violations, “because the details of the telephone uses are generally only within the possession of
the defendant”). For an overview on whether courts will allow discovery in these cases see id. at
696-98.
365
      See FED. R. CIV. P. 9(b).
366
   “ A pleading which sets forth a claim for relief ... shall contain ... a short and plain statement of
the claim showing that the pleader is entitled to relief, ....”
367
   “Each averment of a pleading shall be simple, concise, and direct. No technical forms of
pleading or motions are required.”
368
      “All pleadings shall be so construed as to do substantial justice.”
369
   See Faro, supra note 346, at 689 (citing Haber v. Kobrin, [1982-83 Transfer Binder] Fed. Sec.
L. Rep. (CCH) ¶ 99,259, at 96,161 (S.D.N.Y. June 3, 1983); Bennett v. Berg, 685 F.2d 1053,
1062 (8th Cir. 1982)).
370
      See id. at 689, 696-97.
371
      See supra note 31.
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or other standard form clauses to the consumer’s disadvantage in the U.S. and in

Europe. Partly due to these issues the probability of the plaintiff prevailing in

court will generally be substantially lower than one.


Finally, the international nature of many online transactions leads to yet another

problem in regard to enforcing consumer rights in the courts. Should the

consumer obtain a favorable judgment, this judgement eventually needs to be

recognized and enforced in another jurisdiction. This is, of course, not necessary

when the defendant has assets in the jurisdiction in which the judgment was

entered. In the online environment, however, it has become much easier to

engage in worldwide business without necessarily holding valuable assets

abroad.372 Consequently, if the consumer had the advantage of litigating in her

home country (with the court possibly entering a default judgment in her favor)

she often has the disadvantage of having to have the judgment recognized and

enforced abroad—a timely, costly and often uncertain undertaking which always

contains the risk that the judgment is held unenforceable373 in the jurisdiction



372
    See also Burger King Corp. v. Rudzewicz, 471 U.S. 462, 476 (1985). In this decision the
Supreme Court already observed that “it is an inescapable fact of modern commercial life that a
substantial amount of commercial business is transacted solely by mail and wire communications
across state lines, thus obviating the need for physical presence within a State in which business
is conducted.”
373
    See generally UNIF. FOREIGN MONEY-JUDGMENTS RECOGNITION ACT § 4 (1962); RESTATEMENT
(SECOND) CONFLICT OF LAWS §§ 92, 98 (1971); GARY B. BORN, INTERNATIONAL CIVIL LITIGATION IN
UNITED STATES COURTS 935 (3d ed. 1996) (all listing the grounds for non-recognition of foreign
judgments in the U.S.). The historical basis for recognition of foreign judgments in the U.S. was
laid down in Hilton v. Guyot, 159 U.S. 113 (1895).
Without going into further detail herein (for a more detailed discussion see Rufus Pichler,
Business-to-Consumer Electronic Commerce: The Economics of Litigation and Online Dispute
Resolution C. (Dec. 21, 1999) (unpublished manuscript) (on file with author and the Stanford
Program in International Legal Studies)), two particular prerequisites for recognition of judgments
that exist in almost every jurisdiction should be pointed out: The court entering the judgment must
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where assets can be found.374 The expected judgment therefore does not

necessarily reflect the expected benefit for the plaintiff. If she gets a judgment in

jurisdiction X but the plaintiff only has assets in jurisdiction Y where this judgment

(including an eventual claim for cost reimbursement) is not enforceable, the

plaintiff’s actual benefit is zero.375


ββ)       Costs

Not only does consumer litigation promise only low benefits, it is in general also

relatively costly.376 In our context this problem is aggravated because cross-

border litigation is even more costly. It involves traveling time and costs, the need

to hire foreign counsel, a need for foreign assistance in taking evidence, and




have had personal jurisdiction over the defendant according to the rules on jurisdiction of the
recognizing state. And the defendant must have been served process in an appropriate manner
(see, e.g., Ackermann v. Levine, 788 F.2d 830, 837-38 (2d Cir. 1986)). Regarding the former it
should be noted that in practice the vast majority of online merchants’ terms of use will include
choice of forum clauses establishing exclusive jurisdiction of the courts at the merchant’s principal
place of business. These clauses presently are generally not enforceable in Europe whereas U.S.
courts are very likely to uphold them (see Pichler, supra at II.A.4.). European courts, for example,
therefore would not be hindered by an online choice of forum clause to assert jurisdiction on
general grounds such as local assets, affiliation, or consumer’s place of residence (see Pichler,
supra at A for a detailed discussion of international jurisdiction in regard to online transactions). In
the context of recognition of judgments, however, the different attitudes regarding the
enforceability of these clauses become decisively significant. Since U.S. courts, for example,
honor the clause (leading to exclusive jurisdiction here) a European court’s assertion of
jurisdiction is necessarily inconsistent with American law. This means that a European judgment
that was entered despite the existence of a clause establishing exclusive jurisdiction of U.S.
courts, cannot be recognized and thus not enforced in the U.S.
374
   And of course fraudsters can deliberately hide their assets or locate them in jurisdictions
known not to enforce foreign judgments.
375
   Hereinafter the benefit will be referred to as B. It is assumed that B = J in the case of an
enforceable judgment and B = 0 in the case of an unenforceable judgment.
376
    This has been recognized long ago and led to an intensive discussion on “access to justice”.
See generally Posner, supra note 353, at 439-441. See also Rubin, supra note 214, at 119
(“[The] costs will often be sufficiently large to overwhelm any benefit from judicial enforcement.
This will almost always be the case for consumers, ....”) (emphasis added).

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possible language barriers that may require costly translations of documents.377

Given the low stakes involved it can be assumed that the litigation costs exceed

the expected judgment in the majority of cases, even under the assumption that

the probability of the consumer winning in court is one.378 This alone, however,

does not necessarily lead to a negative-expected value suit, because it depends

on the applicable cost allocation system, whether the consumer actually has to

bear her litigation costs or whether she is entitled to their reimbursement by the

losing party.379 Courts always apply the cost allocation system of the forum.380

For this reason, the decision where to bring suit is also a decision for or against a

specific cost allocation system.


In general, under the American rule, each party has to bear its own litigation

costs. The British and continental system, however, requires the losing party to

reimburse the winning party’s litigation expenses.381 Thus, the plaintiff will bring

suit under the American system when her expected judgment exceeds her




377
      See, e.g., BORN, supra note 373, at 5.
378
   It has been noted above that this is an unrealistic assumption, see supra text following note
358.
379
   See Shavell, Suit, Settlement, and Trial, supra note 353, at 56 (stressing the importance of the
method of cost allocation). See also, Posner, supra note 353, at 428 passim (discussing the
implications of different cost rules). See generally Philipp J. Mause, Winner Takes All: A Re-
Examination of the Indemnity System, 55 IOWA L. REV. 26 (1969) (discussing the American and
the British cost allocation systems).
380
      See, e.g.,
381
   At this point it is assumed that the winning party’s expenses are fully reimbursed. In fact most
systems provide some kind of absolute limitation and generally do not reimburse excessive costs.
See e.g. § 91(1) ZPO (German civil procedure statute) (stating that the opponent’s expenses are
only to be reimbursed to the extent that they were “necessary”). See also infra note 396.

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litigation costs,382 and under the British and continental system when her

expected judgment exceeds the expected litigation costs, being the sum of the

plaintiff’s and the defendant’s costs multiplied by the probability of the plaintiff

losing the case.383 Therefore, even when the plaintiff would win her case for sure,

she would not bring suit under the American cost allocation rule if her costs

exceed the judgment.384 This poses the known “problem of the meritorious small

claim defeated by the litigation-expense threshold”.385


β)          “The Consumer’s Dilemma”

Assume, for example, that a European consumer is thinking of bringing a claim

against an U.S. merchant who has no assets in Europe. This leads to the

following dilemma for the consumer who seeks judicial redress:


The consumer would normally chose to bring suit in Europe because under the

European cost allocation system the losing merchant would have to reimburse

the consumer’s litigation costs and the expected judgment is greater than zero.

However, since her expected judgment will most likely not be enforceable in the

U.S.,386 the consumer’s expected benefit as well as the expected actual



382
   If cp are the plaintiff’s costs and cd the defendant’s costs (Court fees are assumed to be part of
the plaintiff’s costs) then suit will be brought if pJ > cp.
383
   pJ > (1 – p)(cp + cd) or, if the plaintiff’s and the defendant’s costs are assumed to be equal:
pJ > 2c – 2pc. See Posner, supra note 353, at 437.
384
    This problem theoretically does not arise under the British and continental cost allocation rule.
In reality, however, the problem is not solved, see infra note 390 and accompanying text.
385
   See Posner, supra note 353, at 438. See also Bebchuk & Chang, supra note 353, at 373
(suggesting alternative fee shifting rules taking into account the “margin of victory” to solve this
problem).
386
      Assuming an exclusive forum selection clause in favor of a U.S. forum, see supra note 373.
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reimbursement of her costs will be zero. The lack of enforcement turns it into a

negative-expected value suit, the consumer gains nothing and loses her litigation

expenses, and thus she will not bring suit in Europe.


The actual expected benefit is only positive when the consumer brings suit in the

U.S. where the local judgment is per se enforceable. In the U.S., however, the

consumer will have to bear her own litigation costs, which will typically exceed

the expected judgment. Thus, the consumer will not bring suit in the U.S. either.

She will, as a result, never bring suit.387


The above analysis suggests a different outcome, when a suit can be brought

under the European cost allocation system and the plaintiff faces no uncertainty

as to the expected judgment’s enforceability. This would for instance be true if a

U.S. consumer sued a European merchant in Europe, if a European consumer

sued a merchant from another European country in her home courts,388 or if a

European judgment would be enforceable in the jurisdiction in which assets are

located.389




387
    See also Muris, supra note 241, at 105 (“As is well known, however, for consumer
transactions going to court is usually not economically feasible. When disputes involve small
losses to consumers, private lawsuits will not work.”).
388
   Art. 26 of the Brussels Convention guarantees recognition and enforcement of judgments from
a signatory state in any other signatory state.
389
   E.g., in the unlikely case of the absence of a choice of forum clause. Another case would be
one in which the defendant had sufficient assets in the jurisdiction rendering the judgment.

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It is admittedly not as clear as before, but is also very unlikely that the consumer

will actually bring suit in these cases.390 The reasons, however, are different

since under the same conditions as above the expected benefits would actually

exceed the expected costs (being zero after reimbursement).391 The first reason

why even under the European rule small claims will still be defeated by costs is

that the probability of winning is generally not one.392 But even if it is only slightly

less, the costs may quickly exceed the expected judgment.393 Under the

European rule the risk for the plaintiff actually becomes greater, because if she

loses she will not only have to pay her own costs but her opponents’ as well.394


Another reason why small claims won’t be brought under the European cost

allocation rule either is that even the successful plaintiff will not get a full

reimbursement of her costs. This is generally true in the sense that she must

always bear the opportunity costs of time spent during the litigation process.395

Apart of that it is true when American plaintiff’s bring suit in Europe, because of a

substantial uncertainty as to what extent the generally much higher lawyer fees

of an American lawyer will be held reimbursable by, for example., a German



390
   See Posner, supra note 353, at 438 (answering to the suggestion that “if the English practice
of reimbursing the winning party’s attorney and witness fees were adopted in this country, the
problem of the meritorious small claim defeated by the litigation-expense threshold would be
solved. It would not be solved.”).
391
    Remember that in the case of enforceability of the judgment B = J and that the condition to
bring suit under the European rule was J > 0 if p = 1.
392
      See supra text following note 358.
393
    See Posner, supra note 353, at 439 (giving the example the if p = .99 the stakes must be
larger than one fiftieth of the litigation expense for the plaintiff to bring suit).
394
      Cf. Posner, supra note 353, at 428.


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court.396 This theoretical analysis, which suggests that even under the European

cost allocation rule small claims are particularly unlikely to be brought if they

require suing or enforcing a judgment in another jurisdiction, is backed by

existing empirical studies.397 In short it can be concluded that even in the cases

introduced above, the consumer will hardly ever litigate a claim against a foreign

merchant and cannot credibly threaten the merchant to do so in order to extract a

settlement.398 Consequently, individual court enforcement is no viable basis for

consumer reliance.


bb)      Rights to Sue for Consumer Organizations

The problem of judicial redress or access to justice for consumers, whose

meritorious small claims are defeated by high litigation costs, is not unfamiliar. It

is an issue frequently addressed by the European Commission in its efforts to




395
   See Posner, supra note 353, at 438 (“The most important exclusion is the opportunity cost of
the party’s time, ....”); Landes, supra note 353, at 102 (costs from trial delay).
396
   See HAIMO SCHACK, INTERNATIONALES ZIVILVERFAHRENSRECHT para. 580d (2d ed. 1996). See
generally Dieter Leipold, Limiting Costs for Better Access to Justice: The German Approach, in
REFORM OF CIVIL PROCEDURE 265, 266-275 (A.A.S. Zuckermann & Ross Cranston eds., 1995);
Bundesrechtsanwaltskammer [German Bar Association], German Attorney’s Fees (visited Aug.
17, 00) <http://www.brak.de/aktuelles/3Dgebo-e.html> (explaining the German cost allocation
system and its statutory lawyer fees).
397
    See BIRGIT FELDTMANN ET AL., THE COST OF LEGAL OBSTACLES TO THE DISADVANTAGE OF
CONSUMERS IN THE SINGLE MARKET, A REPORT FOR THE EUROPEAN COMMISSION DG XXIV –
 CONSUMER POLICY AND CONSUMER HEALTH PROTECTION 277 (1998) (finding that since “costs in all
member states soon exceed the value of the claim for all amounts of claim below 2,000 ECU,
consumers are effectively barred from seeking redress for their most common problems.”)
(footnote omitted).
398
    The defendant will not agree to settle unless the plaintiff has a credible threat to sue or to
proceed to trial (and assuming that plaintiff and defendant have common knowledge about the
stakes and the costs). See Shavell, Suit, Settlement, and Trial, supra note 353, at 56 n.7; Shavell,
Incentive to Bring Suit, supra note 353, at 338 (suggesting that absent a credible threat to sue the
plaintiff won’t even press a claim against the defendant); Cooter & Rubinfeld, supra note 353, at
1083; Posner, supra note 353, at 439.

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enhance effective consumer protection.399 A recent development in this field is

granting consumer organizations a right to sue in the event of the violation of

specific consumer protection laws.


The most relevant directive in our context, the Distance Contracts Directive,400 for

example, provides that “Member States shall ensure that adequate and effective

means exist to ensure compliance with this Directive in the interests of

consumers.” To understand the scope and significance of this provision one has

to differentiate between two possible types of violation of the Directive’s

provisions: violations harmful to the collective interests of consumers and

violations harmful to individual interests of a consumer. The first basically include

non-compliance with the Directive’s obligations to provide the required

information,401 a use of one of the prohibited aggressive marketing methods,402

or a use of certain means of distance communication without the consumer’s

prior consent or despite her clear objection.403 The latter include individual rights

of consumers, namely the obligation of the supplier to reimburse the sums paid

by the consumer when she exercises the right of withdrawal granted by the




399
    See generally European Commission, Health and Consumer Protection, Access to Justice
(visited                        Aug.                        17,                          00)
<http://www.europa.eu.int/comm/dg24/policy/developments/acce_just/index_en.html>. See also
OECD, Consumer Protection Guidelines, supra note 142, at 7 (calling for a framework that
“provides consumers with meaningful access to fair and timely dispute resolution and redress
without undue cost or burden”).
400
      See supra note 24.
401
      See id. arts. 4, 5.
402
      See id. art 9.
403
      See id. art 10.

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Directive404 and the right to be recredited with the sums paid in the event of a

fraudulent use of her credit card.405


The remedies and means of judicial redress that are available in each of these

cases vary, and it will be shown that the problem of consumer access to justice is

not eased with regard to individual interests.


α)           Collective Interests of Consumers

Referring to the “adequate and effective means ... to ensure compliance with this

Directive” art. 11(2) states that these “shall include” a right for public bodies,

consumer organizations, and/or professional organizations to take action before

courts or competent administrative bodies to ensure that the national provisions

for the implementation of the Directive are applied.


Although art. 11(1) would by itself not necessarily exclude individual consumer

interests from its scope, it has been interpreted as to only refer to collective

consumer interests.406 This is consistent with the Directive on Injunctions for the

Protection of Consumer’s Interests.407 This Directive aims at an approximation of

the laws of the Member States relating to actions for injunctions aimed at the



404
      See id. art. 6(2).
405
      See id. art. 8.
406
    See BMJ, Draft Distance Contracts Act, supra note 69, at 64 (stating that the right of the
aforementioned entities to bring an action was meant to facilitate monitoring of general business
practices, but cannot have been meant to enable these entities to enforce contractual claims of
individual consumers). See also supra note 239 and accompanying text.
407
    Directive 98/27/EC of the European Parliament and of the Council of 19 May 1998 on
Injunctions for the Protection of Consumer’s Interests, 1998 O.J. (L 166) 51. The Directive


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protection of the collective interests of consumers.408 It explicitly excludes

individual consumer interests and the “cumulation of interests of individuals who

have been harmed by an infringement.”409


Any “infringement”, i.e. any act contrary to the Directives listed in the Annex410

(including the Distance Contracts Directive), which harms the collective interests

of consumers,411 may be challenged in the courts by qualified public bodies or

organizations whose purpose it is to protect such interests.412 The actions are

viewed as tort actions (for an infringement of the listed Directive’s provisions)

rather than contract actions, which is relevant to determine the applicable law

and the competent courts. Applying the general rules for tort actions, both the

courts of the Member State where the infringement originated or, more relevant

with regard to foreign merchants, the courts of the Member State where the

infringement has effects can assert personal jurisdiction.413 The effect of the

infringement will generally occur in all states in which consumers are affected by




entered into force on July 1, 1998 and will have to be implemented within 30 months from this
date, see id. arts. 8, 9.
408
      See id. art 1(1).
409
   See id. recitals para. 2. The Directive thus does not introduce class actions. Class actions (in
the U.S.), by the way, have not proven feasible to address the problem of access to justice either,
see, e.g., Muris, supra note 241, at 105 (“Nor have class actions evolved to provide adequate
enforcement [regarding disputes that involve small losses for consumers].”).
410
      These are all Directives related to consumer protection.
411
      See id. art. 1(2) (defining “infringement”).
412
    See id. arts. 2, 3 (defining and specifying the type of actions that can be brought and the
entities qualified to bring them).
413
   The same rule applies to determine the applicable law. See Directive 98/27/EC, supra note
401, art. 2(2) (referring to this general rule of private international law). See also id. recitals para.
6.

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the business practices of the merchant, i.e. all states where that merchant

conducts business.


In sum foreign merchants might have to fear actions for infringement of collective

consumer interests brought in European courts by specific public bodies or

private organizations. The remedy will normally be an injunction requiring the

cessation of the infringement accompanied by an obligation to make payments

into the public purse or to nationally designated beneficiaries in the event of

failure to comply with the decisions.414 The threat to bring these actions is

generally quite powerful taking into account the much better financial equipment

of these entities as compared to individual consumers. And if the merchant has

any assets in Europe she also faces actual enforcement of the decisions. If it

does not have any assets in Europe, however, the practical risk may be

considerably lower due to the uncertainty regarding recognition and enforcement

of the respective actions in the country where that merchant has assets.415


β)           Individual Interests of Consumers

As indicated above, however, the right of qualified entities to bring an action does

not cover claims of individual consumers. It does not include the claim for

reimbursement of the sums paid by a consumer that arises after exercising the

right of withdrawal, or any other claim arising from breach of contract or fraud.

Regarding consumer reliance, the right therefore faces the same limits like



414
      See id. art. 2(1).
415
      See supra note 373.
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criminal       enforcement       actions.416   Consumer      redress     is   not    facilitated.

Consequently, the right of certain organizations to protect collective interests of

consumers—just as criminal proceedings—does not provide a means on which

potential online customers can or will rely to “fix things if they go wrong.”


c)          Organization Enforcement and Codes of Conduct (Self-Regulation)

Ever since the Internet and electronic commerce have drawn increased attention

of policymakers and businesses, “self-regulation” has been a hot topic. Initially

the discussion—mainly in the abundant law journal literature—was polarized. On

the one side stood a somewhat idealistic cyber-libertarian conception of the

Internet as a stateless “place”, in which online communities develop a

comprehensive system of self-governance417 without any state’s interference.418



416
      See supra text following note 347.
417
    See David R. Johnson & David Post, Law And Borders—The Rise of Law in Cyberspace , 48
STAN. L. REV. 1367 (1996). See also David G. Post, Anarchy, State, and the Internet: An Essay
on Law-Making in Cyberspace, 1995 J. ONLINE L. art 3 (June 1995)
<http://warthog.cc.wm.edu/law/publications/jol/post.html> ; David G. Post, The “Unsettled
Paradox”: The Internet, The State, and the Consent of the Governed, 5 IND. J. GLOBAL LEGAL
STUD. 521 (1998); David G. Post, Governing Cyberspace, 43 W AYNE L. REV. 155 (1996); David
G. Post & David R. Johnson, Working Paper, The New Civic Virtue of the Net: Lessons from
Models of Complex Systems for the Governance of Cyberspace, 1997 STAN. TECH. L. REV.
(visited Aug. 17, 00) <http://stlr.stanford.edu/STLR/Working_Papers/97_Post_1/index.htm>; John
T. Delacourt, The International Impact of Internet Regulation, 38 HARV. INT. L.J. 207, 224 (1997);
Amy Knoll, Any Which Way But Loose: Nations Regulate the Internet, 4 TUL. J. INT’L & COMP. L.
275, 301 (1996); Eric J. McCarthy, Networking in Cyberspace: Electronic Defamation and the
Potential for International Forum Shopping, 16 U. PA. J. INT’L BUS. L. 527, 564 (1995). For an
overview on the beginnings of the self-governance discussion see Anne Wells Branscomb,
Anonymity, Autonomy, and Accountability: Challenges to the First Amendment in Cyberspaces ,
104 YALE L.J. 1639, 1665-1670 (1995).
418
    A famous account of this conception is given by John Perry Barlow, A Cyberspace
Independence                 Declaration             (Feb.             9,        1996)
<http://www.eff.org/pub/Publications/John_Perry_Barlow/barlow_0296.declaration>:
„Governments of the Industrial World, you weary giants of flesh and steel, I come from
Cyberspace, the new home of Mind. On behalf of the future, I ask you of the past to leave us
alone. You are not welcome among us. You have no sovereignty where we gather.

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On the other side stood those who feared “cyber-anarchy” and had no problem

with government regulation, since the Internet should not be treated differently.419

As, during the process of commercialization of the Net,420 people more and more

supplanted the term “cyberspace” with “e-commerce” an unlikely alliance formed:

The idea of self-regulation was adopted by business, those “‘immigrants‘ from the

real world who are arriving in droves in the belief that cyberia’s highways are

paved with gold.”421 The alliance was unlikely because these were exactly those

immigrants who threatened (and to the largest extent succeeded) to forever

change the cyber-libertarian’s social space into a mere global marketplace.

Business very much liked the idea of running things on its own, adopting codes

of conduct and other industry standards,422 and trying to avoid government

regulations which were feared to be too constraining for the development of




We have no elected government, nor are we likely to have one, so I address you with no greater
authority than that with which liberty itself always speaks. I declare the global social space we are
building to be naturally independent of the tyrannies you seek to impose on us. You have no
moral right to rule us nor do you possess any methods of enforcement we have true reason to
fear. [...].“
419
   See Jack L. Goldsmith, Against Cyberanarchy, 65 U. CHI. L. REV. 1199 (1998), Jonathan D.
Bick, Why Should the Internet be Any Different? , 19 PACE L. REV. 41 (1998). See also Frank H.
Easterbrook, Cyberspace and the Law of the Horse, 1996 U. CHI. LEGAL F. 207 (1996); Lawrence
Lessig, The Zones of Cyberspace, 48 STAN. L. REV. 1402 (1996); Joel P. Trachtman,
Cyberspace, Sovereignty, Jurisdiction, and Modernism, 5 IND. J. GLOBAL LEGAL STUD. 561 (1998).
420
      See supra note 9.
421
      Dunne, supra note 9.
422
    See, e.g., Alliance for Global Business, supra note 17, at 8 (stating a number of fundamental
principles that should shape the policies that govern electronic commerce, the first of which reads
that “[t]he development of electronic commerce should be led primarily by the private sector in
response to market forces”, and the eighth of which argues that “[t]he protection of users ...
should be pursued through ... industry-led solutions”); Global Business Dialogue on Electronic
Commerce (GBDe), supra note 20, par. 5 (“develop effective self-regulatory and market-driven
mechanisms”). See generally Rothchild, supra note 31, at 946-49 (giving an overview on basic
tools of industry self-regulation).

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electronic commerce.423 On the other hand, government—at least in the

U.S.424—never played the part of the tough adversary and initially propagated a

leadership of the private sector as well.425 Meanwhile, in the regulatory

discussion, the artificial dichotomy of self-regulation versus government

regulation has been replaced by more realistic thoughts about cooperation

between the private and the public sector and on finding the right mix between

the two.426 In some areas, particularly pertaining to privacy, regulators more and



423
   Some argue that commerce acts together with government which regulates code, see
LAWRENCE LESSIG, CODE AND OTHER LAWS OF CYBERSPACE 43-62 (1999). See also Andrew L.
Shapiro, The Disappearance of Cyberspace and the Rise of Code , 8 SETON HALL CONST. L.J. 703
(1998).
424
   The European Union wanted to establish a comprehensive regulatory framework from the very
beginning, see A European Initiative in Electronic Commerce, COM(97)157 final at 12 (“The
objective of the Commission is to implement the appropriate regulatory framework by the year
2000.”), available online at <http://www.ispo.cec.be/ecommerce/legal/documents/com97-
157/ecomcom.pdf>. See also David Church et al., Recent Developments Regarding U.S. and EU
Regulation of Electronic Commerce, 33 INT’L LAW . 347, 347-355 (1999). But see Matthew J.
Feeley, EU Internet Regulation Policy: The Rise of Self-Regulation, 22 B.C. INT’L & COMP. L. REV.
159 (1999) (detecting a policy shift towards supporting industry self-regulation as a reaction to the
release of President Clinton’s framework).
425
    See FRAMEWORK, supra note 15, at 1. (“[G]overnments should encourage industry self-
regulation wherever appropriate and support the efforts of private sector organizations to develop
mechanisms to facilitate the successful operation of the Internet.”). See also W ORKING GROUP I,
supra note 4, at 5 (emphasizing private sector leadership and reliance on market forces instead
of government regulation), at 8 (“privately enforced codes of conduct should be a central
instrument”); W ORKING GROUP II, supra note 4, at 10, 17 (promoting private sector leadership and
the development of effective codes of conduct).
426
    See OECD, Directorate for Science, Technology and Industry, OECD Forum on Electronic
Commerce: Report on the Forum, SG/EC(99)12 at 13 (Nov. 24, 1999), available online at
<http://www.oecd.org/dsti/sti/it/ec/act/paris_ec/pdf/forum_report.pdf> (reporting the concluding
remarks by Mr. Herwig Schlögl, saying that “[p]eople no longer speak of a dichotomy [regarding
the issue of regulation and self-regulation]—rather the challenge is to get the mix between these
complementary approaches right”); Alliance for Global Business, supra note 17, at 10 (“It is
important to recognise the need for global cooperation by both business and governments to
facilitate electronic commerce.”) (but see infra note 430); Ernest T. Patrickis & Stephanie Heller,
The Government’s Role in Electronic Commerce: A Review of the Clinton Administration’s
Framework on Global Electronic Commerce, 18 ANN. REV. BANKING L. 325, 326 (1999)
(discussing the government’s role in supporting business and commerce as laid out in the
framework). See also Llewellyin Joseph Gibbons, No Regulation, Government Regulation, or
Self-Regulation: Social Enforcement or Social Contracting for Governance in Cyberspace, 6
CORNELL J.L. & PUB. POL’Y 475, 509, 523 (1997); Dunne, supra note 9, at 11; Henry H. Perritt, Jr.,

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more start to express doubts, whether self-regulation is still a promising

approach.427 And, without having to decide in general which approach or which

mix is best suited from a regulatory or public policy point of view, doubts are also

appropriate as to whether self-regulation is capable of establishing consumer

confidence—meaning as to whether consumers, from their individual point of

view, are likely to rely on self-regulatory mechanisms.428


Business alliances, however, keep propagating that industry self-regulation and

codes of conduct429 should be favored wherever and to the largest extent




Townhall Democracy or Rediscovered Royalism?, 12 BERKELEY TECH. L.J. 413, 433 (1997) (all
arguing for self-regulation on a contractual basis in the limits of government regulation); Todd H.
Flaming, The Rules of Cyberspace: Informal Law in a New Jurisdiction, 85 ILL. B.J. 174, 179
(1997) (arguing for self-regulation only pertaining to “internal problems”); Joel R. Reidenberg,
Governing Networks and Rule-Making in Cyberspace, 45 EMORY L.J. 911, 926 (1996) (“For global
networks, governance should be seen as a complex mix of state, business, technical, and citizen
forces. Rules for network behavior will come from each of these interest centers.“); I. Trotter
Hardy, The Proper Legal Regime for “Cyberspace”, 55 U. PITT. L. REV. 993, 995, 1025 (1994)
(proposing a step-by-step system from “bottom up“ to „top down“ regulation, starting with pure
self-help and going to contract approaches and ultimately government regulation); Rothchild,
supra note 31, at 968 (government regulation should support and complement the private sector).
427
   See, e.g., Robert Pitofsky, Electronic Commerce and Beyond: Challenges of the New Digital
Age (Feb. 10, 2000) <http://www.ftc.gov/speeches/pitofsky/rpwilson2.htm> (“To date, much of the
online debate has centered around several options -- do nothing to protect consumer privacy
("hands off the Internet"), industry self-regulation, or government regulation. Given the invasions
of privacy that we have seen in the early stages of development of online commerce - some
involving the illegal collection of personal information from kids - and the constant concern by
online participants about invasions of their privacy, the do-nothing option does not seem
appealing.”) (footnote omitted). Privacy advocates like the Electronic Privacy Information Center
(EPIC) agree and also call for enforceable legal protection, see Sarah Andrews & Andrew Shen,
Electronic Privacy Information Center, Public Comment on Barriers to Electronic Commerce: U.S.
Department of Commerce—Office of the General Counsel; Laws or Regulations Posing Barriers
to Electronic Commerce (Mar. 17, 2000) <http://www.epic.org/privacy/internet/Barriers_to_E-
commerce.html>.
428
      See infra II.C.1)c)bb).
429
    For an example of a code of conduct see BBBOnline, Code of Online Business Practices
(visited Aug. 17, 00) <http://www.bbbonline.com/businesses/code/index.htm>. See also OECD,
Consumer Protection Guidelines, supra note 142.

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possible.430 And they can, in fact, point to some well-known historic examples of

successful industry self-regulation.431


aa)      Historic Examples of Successful Industry Self-Regulation

A number of “classic” studies of merchant and industry self-regulation and of

informal enforcement mechanisms suggest the suitability of these mechanisms to

ensure desired behavior within a specific group of agents under specific

circumstances. These studies include432 more recent phenomena such as

Bernstein’s analysis of extralegal contractual relations in the diamond industry,433

as well as self-regulation in the pre-industrial era such as enforcement




430
   See Alliance for Global Business, supra note 17, at 6 (“The pace of change and nascent state
of electronic commerce have heightened the risks associated with premature or unnecessary
government regulation. This has increased the responsibility of business to promote a trustworthy
environment through self-regulation and technological innovation. Business has a strong market
incentive to foster the empowerment of users, but will only make the necessary investments if it
can trust that governments will recognise and reinforce the leadership of business in responding
to the highly dynamic nature of electronic commerce.”) (emphasis added); Global Business
Dialogue on Electronic Commerce (GBDe), supra note 20, par. 7 (“[W]e give precedence to
effective self-regulation and technological solutions wherever possible ... any intervention of
public authorities should be narrowly tailored, ....”).
431
   And implicitly they do, see Alliance for Global Business, supra note 17, at 6 (“Self-regulation is
not a new phenomenon. Throughout history, business has set its own standard rules and
practices through a variety of organisations to lower transaction costs, to avoid and resolve
conflicts, and to create consumer confidence.”).
432
   For a general overview see, for example, Lisa Bernstein, Private Commercial Law, in 3 THE
NEW PALGRAVE, supra note 149, at 108; Avner Greif, Institutions and International Trade: Lessons
from the Commercial Revolution, 82 AEA PAPERS & PROC. 128 (1992) [hereinafter Greif,
Commercial Revolution]; Avner Greif, Informal Contract Enforcement, in 2 THE NEW PALGRAVE,
supra note 149, at 287 [hereinafter Greif, Contract Enforcement].
433
   See Lisa Bernstein, Opting Out of the Legal System: Extralegal Contractual Relations in the
Diamond Industry, 21 J. LEGAL STUD. 115 (1992).

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mechanisms at medieval champagne fairs,434 the coalition of Maghribi traders in

the 11th century,435 or the merchant guilds.436


The diamond industry, to the largest extent, operates outside the formal legal

system. It has developed its own internal business norms and customary

practices, provides an exclusive arbitration system in cases of a breach of these

rules, and has found effective ways to enforce its own rules “completely outside

the legal system.”437 Similar mechanisms have evolved in other exchanges, the

New York Stock Exchange—early in its history—being cited as a prominent

example.438 Exchanges created standardized systems of measuring the

attributes of commodities, formulated rules of trade and acceptable or

unacceptable behavior, imposed disclosure obligations, mediated disputes, and

provided for contract enforcement by arbitration.439 Less recent examples of self-

regulation go back to a time characterized by the “absence of appropriate legal

enforcement provided by the state.”440 Given this paper’s preceding analysis of



434
   See Paul R. Milgrom et al., The Role of Institutions in the Revival of Trade: The Law Merchant,
Private Judges, and the Champagne Fairs, 2 ECON. & POL. 1 (1990).
435
   See Avner Greif, Contract Enforceability and Economic Institutions in Early Trade: The
Maghribi Traders’ Coalition, 83 AM. ECON. REV. 525 (1993).
436
   See Avner Greif et al., Coordination, Commitment, and Enforcement: The Case of the
Merchant Guild, 102 J. POL. ECON. 745 (1994).
437
      See Bernstein, supra note 433, at 138, 157.
438
   See Stephen Craig Pirrong, Self-Regulation of Private Organized Markets, in 3 THE NEW
PALGRAVE, supra note 149, at 433, 434. Later, however, these exchanges more and more
became subject to government-regulation, see id. at 437 (“Governments have largely supplanted
exchanges in several crucial areas of regulation.”).
439
      See id. at 434.
440
   See Greif, Contract Enforcement, supra note 432, at 288. The historic background is the re-
emergence of long-distance trade in Europe and the Mediterranean region in the eleventh to
fourteenth century.

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the role and effectiveness of state enforcement in the online context, the current

situation seems quite comparable.441 While common state rules where lacking,

merchants created their own norms of trade, namely the law merchant, which

was applied by private judges, often merchants themselves.442 But the Law

Merchant system was eventually replaced by a “system of state enforcement ...,

especially in later periods when nation states exercised extensive geographic

control.”443 When, however, as in the current period of globalization, nation

states’ geographic control arguably becomes increasingly toothless, it seems that

an argument for a revival of the self-regulatory lex mercatoria (in the form of a lex

informatica) could be made.444 Another example of successful self-regulation in

the late middle ages is the merchant guild, which successfully ensured “the

coordination and internal enforcement [of its norms and regulations]” needed to

permit effective collective action.445




441
   Even more so, when one notes that one of the main reasons for the lack of state enforcement
then—as today—are “the boundaries of the state’s jurisdictional power” and the resulting
“absence of ... authority over (all) those parties to the exchange who can gain from breaching the
contract.” See id. at 287.
442
      See, e.g., Milgrom et al., supra note 434, at 2, 4-6.
443
      See id. at 20.
444
    In fact, of course, it is made. See Joel R. Reidenberg, Lex Informatica: The Formulation of
Information Policy Rules Through Technology, 76 TEX. L. REV. 553 (1998). See also Robert D.
Cooter, Structural Adjudication and the New Law Merchant: A Model of Decentralized Law, 14
INT’L REV. L. & ECON. 215, 216 (1994) (referring to rules and norms within modern business
communities as the new law merchant).
445
    See Greif et al., supra note 436, at 748. The collective action was the coordinated response by
a large fraction of merchants in the form of a boycott, when a ruler did not provide some of them
the necessary protection, see id. at 753. In our context the fact that the internal norms to act in a
specific way (boycott) were successfully enforced is the important part.

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bb)         It’s a Different World Online—The Failure of Self-Regulation as a
            Basis for Consumer Reliance

These examples show that self-regulation may work—under specific conditions.

These conditions, however, are the important part, and they are not met in the

online world.


In some of the examples, self-regulation was limited to internal relations, to acts

that have effects only within the regulatory group or association. The Law

Merchant, for example, regulated trade between merchants rather than

establishing rules for retail to non-merchants. Also, in the diamond industry, the

trading norms, dispute resolution and enforcement mechanisms are only

employed in dealings between dealers that are members of the bourse.446

Agreements involving the rights of third parties do not fall within the industry’s

extralegal regime.447 This, however, is not a necessity. It may very well be in the

interest of the self-regulating group to address behavior of members that will

have external effects because these effects can backfire and have negative

consequences for the group as a whole. Early exchanges, for example,

articulated rules against fraud of external investors by members of the

exchange,448 presumably because all the exchange members were at risk of

losing their credibility if one of them engaged in such behavior. A similar external



446
  See Bernstein, supra note 433, at 152 (saying that nonmembers might behave in a certain
way not to hurt their chances of joining the bourse, but not speaking of any incentives for
members to do so, when they deal with nonmembers).
447
      See id. at 154.
448
   See Pirrong, supra note 438, at 435 (“Exchanges have also devised means of protecting
investors against fraud and the consequences of default by brokers.”).
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regulation existed in the merchant guild. Members of the guild were forced to

take part in the boycott of a nonmember—a ruler or city that did not afford one or

a few of the guild members the necessary protection.449 Propagated self-

regulation of online merchants would operate in a comparable manner. Online

merchants would agree to specific codes of conduct pertaining to behavior

towards consumers, i.e. behavior with external effects. Thus, in this regard online

self-regulation is not significantly different from some forms of successful self-

regulation discussed above. The difference between a purely internal and an

external self-regulation, however, is noteworthy nevertheless. When relating to

externalities, self-regulation has frequently turned out to be less viable and to a

large extent to be supplanted by government regulation.450


However, the key difference between the successful examples of self-regulation

discussed above and the propagated self-regulation of online merchants—which,

for exactly this difference, will not be successful—is another. It is the lack of

internal enforceability in the online world. In each of the examples discussed

above, self-regulation was successful because the regulating group or

association had the power to enforce its norms against its members and coerce

them to comply with them. The group could credibly threaten to impose sanctions



449
    See Greif et al., supra note 436, at 752 (“In each case, merchants imposed a collective
punishment on the city that included participation by merchants who had not been directly
injured.”).
450
    See Pirrong, supra note 438, at 437 (pointing to commodity exchanges and future trading,
where “current law does not rely exclusively upon self-regulation to reduce the frequency of
manipulation and fraud”); Bernstein, supra note 432, at 114 (pointing to asymmetries in
information and unequal bargaining power that can give rise to questioning the legitimacy of
private commercial law).

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on potential deviators that were severe enough to make them play by the rules

from the outset most of the times. Greif, for example, notes that for the merchant

guild to be successful it was crucial that it was an “organization with the ability

both to coordinate ... decisions and to enforce them by applying sanctions on its

own members.”451 In the context of the guilds these sanctions consisted primarily

of excluding a member from important trading places or expelling them from the

guild altogether.452 In other contexts, too, merchants were induced to behave

honestly by the threat of being boycotted or ostracized.453 Similarly, diamond

trading clubs would impose fines on members who did not honor the internal

norms or ultimately expel them from the trading club,454 and exchanges would

suspend or expel members under similar circumstances.455


The value of the membership to the member (or the cost of losing it) is a crucial

factor for expulsion to be a credible threat. Since membership in each of these

groups is voluntary to begin with, merchants cannot literally be compelled to obey

a rule. They could always leave or withdraw.456 The viability of the whole system

of organization enforcement thus depends on whether the benefits of group

membership exceed the costs of obeying the group’s norms (or the benefits of



451
      See Greif et al., supra note 436, at 753.
452
      See id. at 757, 760.
453
    See Milgrom et al., supra note 434, at 3, 6. As a second step, “a merchant who fails to deliver
a punishment, say by participating in a boycott, when he is supposed to do so is himself subject
to punishment by the community of merchants.” See id. at 8.
454
      See Bernstein, supra note 433, at 120, 129.
455
      See Pirrong, supra note 438, at 434.



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breaking them).457 In the “classic” examples discussed above, this was clearly

the case. A diamond dealer, who does not have access to the trading clubs, will

be at a competitive disadvantage. 458 In fact, “[b]eing subject to these types of

sanctions [suspension, expulsion] makes it unlikely that a trader will be able to

remain in the diamond business” at all.459 The fact that club membership is

essential to maintaining a viable business gives the club a strong leverage to

actually force members to comply with the self-regulatory regime. Similarly,

exclusion of a medieval merchant from the guild and the trading places,

protection, and economic rent it provided460 or from important trade fairs,461 was

likely to mean the end of that merchant’s business.


In the online context, however, these conditions are not met. While a high degree

of interdependency among merchants is needed to make threats of boycott or

expulsion credible, electronic commerce is, to the contrary, characterized by its

high degree of autonomy. People can be authors and publishers of their works,

and merchants can be manufacturers, marketers, and distributors of their

products or services at the same time.462 Online “anyone with a laptop and a



456
   See id. at 436 (stating that “the voluntary nature of an exchange limits its coercive power” and
that a member cannot literally be comp
457
   See also id at 436; Bernstein, supra note 432, at 109 (“the effectiveness of these sanctions
varies and is closely linked to the value of association membership”).
458
      See Bernstein, supra note 433, at 119.
459
      Bernstein, supra note 432, at 109.
460
      See Greif, Contract Enforcement, supra note 432, at 289; Greif et al., supra note 436, at 758.
461
      See Milgrom et al., supra note 434, at 20.
462
    See also Heckman, supra note 113, at 1.2 (“Many vendors can sell globally without the costly
infrastructure of world-wide retail stores, sales offices, distributors, or warehouses.”).

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modem can open a storefront and have access to a global marketplace.”463 The

dependency on suppliers, distributors, trading partners, or entrance to physical

trading places diminishes,464 and consequently the leverage of industry groups or

trade associations does, too. While this is clearly the case in regard to merchants

providing services or information, which can be self-generated, it seems less

clear in regard to tangible products. These still have to be produced and

delivered which arguably would put manufacturers and distributors in a position

to impose sanctions on fraudulent merchants. In theory this is true. The problem

with fraudulent merchants, however, is that they typically neither have, nor

deliver the goods they are selling to consumers.465


When the U.S. Government’s Working Group on Electronic Commerce asserts

that “[s]elf-regulation in the digital age will require the private sector to engage in

much greater collective action to set and enforce rules than was characteristic of

the Industrial Age”,466 we face a dilemma. The very nature of electronic

commerce and the increasing autonomy of agents in this field makes it much

more difficult if not impossible for the private sector to engage in such collective

action and to enforce rules than it was in the Industrial age, which was

characterized by a much higher degree of dependencies and interdependencies.




463
      W ORKING GROUP II, supra note 4, at v.
464
   See also OECD, Business-to-Consumer Electronic Commerce: Survey of Status and Issues,
OCDE/GD(97)219, at 39 <http://www.oecd.org/dsti/sti/it/ec/prod/gd97219e.pdf> (“Today, it is no
longer necessary to have stocks, means of transportation, warehouses, or money collection
systems.”). Why means of transportation or money collection systems are assumed to no longer
be necessary remains unexplained, however.
465
      See supra note 112 and accompanying text.
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Absent a credible threat of internal enforcement, industry self-regulation remains

voluntary. Self-regulation, as it has been put, “only binds the ‘good guys’.”467

Then, however, it cannot be a basis for consumer reliance. If industry norms, for

example obligating merchants to refund consumers, cannot be enforced, a

consumer cannot be confident that things can be fixed should they go wrong.

Industry norms under these conditions only make sense as long as they are

complied with. When a consumer has been defrauded, they are of no use,

because they cannot effectively ensure consumer redress. This is not to say that

industry self-regulation is useless altogether. Although the norms don’t provide

enforcement and therefore are no basis for consumer reliance, the fact that they

may be adhered to by “the good guys” might become relevant in the context of

compliance and trust.468


d)           Informal Enforcement of Social Norms

For similar reasons, social norms will not provide an effective enforcement

mechanism in the online context either. This would require the existence of a

close-knit, interdependent, and to a great extent homogenous community.469




466
      See W ORKING GROUP I, supra note 4, at 8.
467
   See Rothchild, supra note 31, at 964 n.291 (citing Angela Drolte, U.S. Consumers Advocate
Doubts Effectiveness of Industry-Initiated Online Privacy Policies, 2 ELECTRONIC COMMERCE & L.
REP. (BNA) 601 (June 13, 1997) who quotes the testimony of Janlori Goldman at an FTC public
workshop on consumer information privacy).
468
      See infra II.D.
469
    See ELLICKSON, supra note 213, at 177 (“[W]elfare-maximizing norms emerge in close-knit
settings .... [A]n informal-control system may not be effective if the social conditions within a
group do not provide members with information about norms and violations and also the power
and enforcement opportunities needed to establish norms .”) (footnote omitted) (emphasis added)
and at 181 (defining a close-knit group “as a social network whose members have credible and
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While such a group, consisting of technologically sophisticated experts with a

common understanding and an unwritten code of behavior might have existed in

the early stages of the Internet, it doesn’t any more. With the commercialization

of the net470 the formerly homogenous group of users is split into merchants and

consumers.471 And even within each of these groups one is likely to find a

heterogeneous structure of social, cultural, economic, moral, and criminal

versatility and diversity. The times in which the majority of users were familiar

with the behavioral norms of “netiquette”472 are over.473 Thus, even identifying

commonly accepted social norms would most likely be impossible.474 Enforcing

them, due to the lack of interdependence and social ties within and among the



reciprocal prospects for the application of power against one another and a good supply of
information on past and present internal events”) (emphasis added). See also Henry H. Perritt,
Jr., Dispute Resolution in Electronic Network Communities, 38 VILL. L. REV. 349, 359-60 (1993)
(“Professor Ellickson and all the other commentators writing on this subject also recognize,
however, that there are important preconditions for informal community governance without a
major role for law. Most important among these is the likelihood of continuing relationships among
the people making, enforcing and violating the rules and the existence of multidimensional
relationships in the community.”) (footnote omitted).
470
      See supra notes 9, 420.
471
    Cf. Gibbons, supra note 426, at 478 (“putative needs of the growing commercial sector of the
Internet and the demands that it is making on governments is the greatest threat to the existing
libertarian paradigm in Cyberspace”).
472
   For a description of these norms see, for example, David E. Sorkin, Revocation of an Internet
Domain Name for Violations of “Netiquette”: Contractual and Constitutional Implications, 15 J.
MARSHALL J. COMPUTER & INFO. L. 587, 597-99 (1997). Compilations of rules of netiquette can be
found on numerous sites on the web. One of the most referred to seems to be Network Working
Group,     Request        for   Comments:     1885—Netiquette     Guidelines     (Oct.    1995)
<http://www.ietf.org/rfc/rfc1855.txt>.
473
    See also Dunne, supra note 9, at 8 (“[t]his aspect of cyberian character seems slowly to be
eroding”); FUKUYAMA, supra note 145, at 196 (stating that as the number of Internet users rose it
included some “who did not feel bound by the ethical constraints of the original Internet
community”).
474
   See also Perritt, supra note 469, at 360 (“As the scope of networking increases, the likelihood
that users will share values and feel membership to be essential decreases.”). The breakdown of
the consensus regarding the impermissibility of spamming (unsolicited commercial email), which


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two groups, definitely is. Classic tools that the “cybercommunity” used to employ

in response to behavior it disapproved of will hardly induce fraudulent merchants

to change their behavior. This “social enforcement model”475—using flaming,476

banishment,477         disconnection,478       or     mailbombing479—will        be    increasingly

ineffective because rule violators don’t care, find alternative net access that is

beyond the reach of the “enforcers”,480 or use technological protections.481 Most

importantly, however, none of these “enforcement” mechanisms is capable of

redressing defrauded consumers. The reach of the internal enforcement tools of




meanwhile is obviously no longer regarded impermissible by a number of merchants, is just one
example.
475
      See Perritt, supra note 469, at 355. See also Gibbons, supra note 426, at 510.
476
      The public expression of disapproval, see, e.g., Gibbons, supra note 426, at 493-94.
477
   A sanction frequently employed in Multiuser Dungeons (MUD’s). For a general description of
MUD’s see Pavel Curtis, MUDding: Social Phenomena in Text-based Virtual Realities, in HIGH
NOON ON THE ELECTRONIC FRONTIER, supra note 9, at 347. The most famous example of such a
banishment or toading (a virtual death penalty) is that of Mr. Bungle from the virtual community
LambdaMoo (For a detailed description of Lambda Moo see Charles D. Siegal, Rule Formation in
Non-Hierarchical Systems, 16 TEMP. ENVTL. L. & TECH. J. 173, 199-208 (1998)). Mr. Bungle was
spoofing other characters of the community and engaged in “sexually explicit verbal rape” (Wells
Branscomb, supra note 417, at 1662). For a description of this case see also Flaming, supra note
426, at 177; Gibbons, supra note 426, at 522; Rothchild, supra note 31, at 967; Julian Dibbell, A
Rape in Cyberspace; or How an Evil Clown, a Haitian Trickster Spirit, Two Wizards, and a Cast of
Dozens Turned a Database Into a Society, in HIGH NOON ON THE ELECTRONIC FRONTIER, supra
note 9, at 375.
478
   Also known as denial or termination of access. See Perritt, supra note 426, at 464; Perritt,
supra note 469, at 356 (“disconnection enforcement model”); Reidenberg, supra note 426, at 920.
479
    See Wells Branscomb, supra note 417, at 1657-59; Flaming, supra note 426, at 176 (both
describing the often cited case of the law firm Canter & Siegel whose server broke down as a
consequence of masses of emails sent by users who disapproved of a previous spam by that
firm).
480
   See Perritt, supra note 469, at 356 (“This simple remedy hides the fact, ..., that the user of
network services is not really at the mercy of the rule setter, the supplier. If the user does not like
the content of the rules, if the maker of the rules does not follow them or if the user is wrongfully
disconnected, the user simply switches to another network. In a perfectly competitive market, this
is not a problem for the user. It is as painless as calling one telephone number instead of
another.”).
481
   Spammers frequently use “dead” email addresses so that the returned mailbomb ends up in
oblivion.

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cyberspace is limited to assets in cyberspace—they cannot reach material assets

or bank accounts in the real world. This latter limitation—regardless of whether

social norms may (still) be identified in the online environment and of whether, if

they can, online “enforcement” tools can effectively be employed—renders the

social enforcement model completely unsuitable as a basis for consumer

reliance. Consumers simply cannot have the confidence that the social

enforcement model will fix things if they go wrong and compensate a consumer

for an eventually incurred loss, because this model just can’t do it.


2)          Compliance
The ineffectiveness of traditional enforcement mechanisms does, of course, not

mean that every merchant behaves opportunistically all the time. Often, rational

merchants will find it in their own interest to live up to agreements even though a

third party could not effectively coerce them to do so. This is referred to herein as

voluntary482 compliance483 and it is also frequently discussed under the heading

of “self-enforcing contracts.”484 The economic mechanisms that lead to this kind




482
   Voluntary in the sense that no third party could actually force the merchant to comply.
Voluntary does not mean, however, that a merchant does not feel compelled to comply out of
economic considerations (namely because he fears non-legal sanctions).
483
      See also supra note 216.
484
    See, e.g., Greif, Contract Enforcement, supra note 432, at 289 (describing the decisions of the
merchant guilds and multilateral punishment of violators by the coalition of Maghribi traders as
self-enforcing—due to the formers’ ability to exclude and the latters’ collective retaliation if only
one of them was cheated).See also Benjamin Klein & Keith B. Leffler, The Role of Market Forces
in Assuring Contractual Performance, 89 J. POL. ECON. 615, 636 (1981) (“non-third-party method
of contract enforcement”).

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of self-enforcement are non-legal sanctions.485 In our context two grounds for

such sanctions (i.e. ceasing to transact in the future) are of particular interest:

experience and reputation.486 Both deal with reactions of potential future

customers, but they are distinct in regard to the specific individual or group that

imposes the non-legal sanction. Experience means the personal experience of

only one specific customer with a particular merchant. This experience is the

basis for her decision to transact with that merchant again. Reputation, on the

other hand, depends on the dissemination of information about someone else’s

experience to other people that have not yet had any personal experience with

that particular merchant and whose decision whether they will in the future

obviously depends on whether the reputation is good or bad.


a)          Experience (Bilateral Reputation Mechanism)

Merchants who want to establish long-term relationships with their customers

and would like them to engage in repeat dealings, are well advised to comply

with their obligations—even in the absence of a credible enforcement threat. As

Macaulay noted, you don’t get many repeat orders from unhappy customers.487




485
    See generally David Charny, Nonlegal Sanctions in Commercial Relationships , 104 HARV. L.
REV. 373 (1990); Klein & Leffler, supra note 484; Eric A. Posner, The Regulation of Groups: The
Influence of Legal and Nonlegal Sanctions on Collective Action, 63 U. CHI. L. REV. 133 (1996).
486
     This distinction is also implicitly suggested by Macaulay, supra note 199, at 63-64 (“One is
concerned with both the reaction of the other party in the particular exchange and with his own
general business reputation. ... [S]ellers hope for repeat orders, and one gets few of these from
unhappy customers. ... Not only do the particular business units in a given exchange want to deal
with each other again, they also want to deal with other business units in the future.”) (emphasis
added). Others speak of a bilateral and a multilateral reputation mechanism (see, e.g., Greif et
al., supra note 436, at 748, 751), basically making the same distinction.
487
      See Macaulay, supra note 199, at 63.

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The theory of repeated games points out, that, in an iterated Prisoner’s Dilemma,

an agent will not engage in further transactions with the same partner,488 when

her counterpart behaved opportunistically in the preceding game.489 Because of

this consequence a merchant who does not comply in game one might make a

larger profit (i.e. get something for nothing)490 in that round but risks to lose future

income from potential repeated dealings with that customer. When the long-term

benefits from repeated dealings exceed the short-run profit from defecting, the

merchant has an incentive to cooperate and the contract becomes self-

enforcing.491 The relationship itself becomes a valuable asset and serves as a

bond.492 Note, however, that a merchant won’t comply when the gain from

dishonest behavior is larger than the expected future income:493 “The committing

party will breach whenever the benefits of breach out-weigh the cost of sacrificing

the bond.”494 This may frequently be the case when a merchant who behaves



488
  Trading with the same partner, or “clientization,” is central to bilateral reputation mechanisms.
See, e.g., Milgrom et al., supra note 434, at 7.
489
   See generally ROBERT AXELROD, THE EVOLUTION OF COOPERATION (1984); DOUGLAS G. BAIRD
ET AL., GAME  THEORY AND THE LAW 159-87 (1994) (discussing the theory of repeated games);
HOFSTADTER,   supra note 174, at 717 (discussing the iterated Prisoner’s Dilemma). See also
Charny, supra note 485, at 393 (“The asset posted is the value of future dealings; if one party
breaches, the other party will terminate the relationship and refuse to deal with the breacher
again, destroying the asset.”). For a discussion of specific variations of repeated games see, for
example, Drew Fudenberg & Eric Maskin, The Folk Theorem in Repeated Games With
Discounting or With Incomplete Information, 54 ECONOMETRICA 533 (1986); David M. Kreps et al.,
Rational Cooperation in the Finitely Repeated Prisoners’ Dilemma, J. ECON. THEORY 245 (1982).
490
      See supra note 178.
491
      See also Bernstein, supra note 431, at 112; Greif, supra note 435, at 530.
492
      See Milgrom et al., supra note 434, at 1; Charny, supra note 485, at 393.
493
    See Milgrom et al., supra note 434, at 1. See also NORTH, supra note 143, at 55 (“Contracts
will be self-enforcing when ... the benefits of living up to contracts will exceed the costs.”).
494
   Charny, supra note 485, at 408. See also Klein & Leffler, supra note 484, at 616 (“[I]t is
possible that economic agents ... may find it wealth maximizing to break such potentially long-
term exchange relationships and obtain a temporary increase in profit.”).
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opportunistically just risks to lose the one customer it defrauded. Particularly in

the context of online commerce the merchant could go on dealing with a virtually

global customer base.495


b)          Reputation (Multilateral Reputation Mechanism)

The last point explains why multilateral reputation mechanisms are a much

stronger tool to induce self-enforcement of contracts. When not only the

defrauded individual consumer refrains from repeat transactions with a merchant,

but all or at least a large group of consumers boycott that merchant, the threat of

the sanction will be considerably more powerful.496 As a consequence of such a

coordinated approach, a merchant who cheats one consumer risks to deprive

itself from future revenues of potential dealings with all consumers.497 This

mechanism is known as collective punishment.498 It was, for example,

successfully employed by the coalition of Maghribi traders who collectively




495
   See also Greif et al., supra note 436, at 751 (showing in another context that “the value of the
stream of future rents collected by the ruler [herein: merchant] from an individual marginal
merchant [herein: consumer] is almost zero”).
496
   Cf. id. (“A possible means to increase the punishment is a multilateral response by all the
merchants [herein: consumers] to transgressions against any subgroup of [them]”). See also
ANNETTE BAIER, POSTURES OF THE MIND 188 (1995) (“That I won’t trust you again if you break your
promise to me ... is not great threat to you, if you do not need me to trust you again. But if I can
have you as it were stigmatized, so that others recognize you as someone not to be trusted, then
you have a fairly strong self-interested reason not to break your promise to me. ... I can harm
your reputation, I can spread the word that you are not to be trusted.”).
497
   See also Bernstein, supra note 432, at 112 (“when past transactional behavior is observable
by a significant number of participants, breach of contract as to one transactor is transformed into
breach of contract as to numerous market transactors for the purposes of a transactor’s
commercial reputation”).
498
      See, e.g., Greif, Informal Contract Enforcement, supra note 432, at 289.

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retaliated against an agent who had cheated one of their members,499 or the

merchant guilds in the event of transgressions against a single member.500


Inducing self-enforcement of contracts by collective punishment if a merchant

defects, however, is subject to specific conditions. Although examples of

successful multilateral reputation mechanisms so far can mostly be found in

homogenous           and    relatively   small    groups,501   this   is   not   a   necessary

precondition.502 The factor that has limited the mechanism to small groups as a

matter of fact was information.503 As Greif pointed out, multilateral reputation

mechanisms are doomed to fail “[i]n a world characterized by information

asymmetries, slow communication, and different plausible interpretation of

facts.”504 Small homogenous groups, like the coalition of Maghribi traders, are

much more likely to have the social and commercial network needed to provide




499
      See Greif, supra note 435, at 526, 530.
500
    See Greif et al., supra note 436, at 752 (collective punishment by merchants on a city that
included participation by merchants who had not been directly injured).
501
    See Bernstein, supra note 433, at 140 (“Reputation bonds are generally assumed to be
effective only within geographically concentrated, homogenous groups who deal with each other
in repeated transactions over the long run.”); Charny, supra note 485, at 418 (“Collective
reputational enforcement should work well in markets in which single, third-party decisionmakers
wield nonlegal sanctions—that is, in markets limited to a small, homogenous group of individuals
who are in frequent contact and thus can share relevant information.”). Charny, id. at 419, also
points out, however, that “[t]hese markets are, of course, relatively rare.”
502
   But see BAIER, supra note 496, at 189 (“The informal enforcement of promises by withdrawal
of community trust from the word of a known promise-breaker works only as long as the
community is small enough for word to get around when anyone proves not to be a reliable
person, not a ‘man of his word.’”).
503
    See also Milgrom et al., supra note 434, at 3 (pointing out that “reputations for honesty can
serve as an adequate bond for honest behavior if members of the trading community can be kept
informed about each other’s past behavior ”) (emphasis in original).
504
      Greif, Commercial Revolution, supra note 432, at 129.

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the information required to detect and announce cheating.505 But it is asserted

that theoretically506 a multilateral reputation mechanism could also function in

large-scale consumer markets. However, “mass markets based on reputational

bonds are feasible only with technology that conveys information cheaply to a

large group of transactors, such as computers used to monitor creditworthiness

or mass media used in advertising.”507 Moreover, just conveying information

cheaply is not enough. The information has to be conveyed accurately and must

enable “other market participants [to] discover and correctly analyze the

breach.”508 And while it is true that just conveying information is easier and

cheaper than ever in the era of the Internet, this does not necessarily lead to

“better and more complete information”509 of consumers. With the amount of

information available on the Net it has become considerably more difficult to

assess its truth and to correctly analyze or simply process it.510 People who ever

typed in a keyword in one of the major search engines and then tried to figure out

which of the thousands of results would be the most helpful will know that effect.



505
      See id. at 130.
506
    A study of multilateral reputation mechanisms in mass markets overcame the major problem
only by assuming that “consumers costlessly communicate among one another” from which
followed that “if a firm cheats and supplies to any individual a quality of product less than
contracted for, all consumers in the market learn this and all future sales are lost.” See Klein &
Leffler, supra note 484, at 617. Note that the study, id., found that “even such perfect
interconsumer communication conditions are not sufficient to assure high quality supply”! Milgrom
et al., supra note 434, at 3 argue that in a large community it would be too costly to keep
everyone informed about what transpires in all trading relationships.
507
      Charny, supra note 485, at 419.
508
      See id. at 420.
509
      This is suggested by DIGITAL ECONOMY I, supra note 4, at 42.
510
    See also NORTH, supra note 143, at 23 (arguing that “the subjective and incomplete
processing of information plays a critical role in decision making”).

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Particularly in regard to information about merchants and their past behavior it is

possible that consumers will get confused by contradicting information from

different sources.511 Consider also how easy it is to spread false information for

both merchants and consumers. Then, coming back to the obstacles for

multilateral reputation mechanisms identified by Greif,512 we find that slow

communication is not a problem any more, but different plausible interpretations

of facts—and very likely even different facts—will be a remaining problem.


In sum, while mere information retrieval and sharing has in fact become cheaper

and easier in the Internet environment, dealing with the new flood of information,

processing, organizing, assessing, analyzing, and verifying it, and picking out the

useful pieces from the mass has become much more difficult and time

consuming. All this suggests that a multilateral reputation mechanism in

business-to-consumer electronic commerce entails enormous transaction costs.

These costs are likely to render non-legal sanctions and the self-enforcement of

contracts          impractical    unless     new      institutions,   namely      information

intermediaries,513 are able to significantly lower these transaction costs. Whether

this is the case shall be discussed later.514 For now, however, it shall



511
   See also Rothchild, supra note 31, at 964 (“By conveying misinformation to consumers,
swindlers intend to interfere with the workings of consumer sovereignty, and they often
succeed.”).
512
      See supra note 504.
513
    Cf. Bernstein, supra note 432, at 110 (referring to trade associations as information
intermediaries in some commercial relationships); Greif, Commercial Revolution, supra note 432,
at 130 and Greif, supra note 435, at 526 (pointing out that the Maghribi’s reputation mechanism
worked only because it was coupled with a network for information transmission).
514
      See infra III.A.

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nevertheless be assumed that some merchants will, out of reputational

considerations, actually feel compelled to comply with their obligations despite

the problems that multilateral reputation mechanisms face.


c)          ... And Those Who Don’t Care

But there will also be a certain number of merchants who do not care about their

reputation because they do not intend to build repeat-dealing relationships with

customers.515 It has been noted above that, as a matter of fact, a significant

amount of merchant fraud is taking place on the Internet.516 Online scam

schemes are set up until the word spreads among consumers, then they

disappear and pop up again under a different name and design.517 This is

lucrative for scam artists because the set up costs are next to zero while at the

same time the Internet allows access to a global market of potential victims.

Fraudulent merchants typically don’t care about (and don’t expect) repeated

dealings with a customer,518 they rather concentrate on tricking as many one time

only consumers as possible. The main reason why such a scheme can be

profitable even when its operating period is very short lies in the negligible



515
    See also Rothchild, supra note 31, at 964 (“Legitimate marketers recognize that a reputation
for honesty is a prerequisite to long-term business success. The market provides them with a
strong incentive to keep their customers happy. But perpetrators of fraud have no such interest.
They do not need or expect to profit from repeat business or referrals from satisfied customers,
and do not expect to remain long in the market.”).
516
      See supra II.A.2).
517
   See also BAIER, supra note 496, at 188 (pointing out that it is fairly easy for me to assure you
not to trust you again if you break your promise to me, “unless you disguise yourself when you
return with tempting offers”) (emphasis added).
518
  And even apart from fraudulent exchanges it is true that “[m]any times the exchange is a once
and for all exchange and not repeated at all.” See NORTH, supra note 143, at 57.

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investment necessary to enter (and re-enter) the online market. It has been

recognized elsewhere that “expulsion may not deter the manufacturer from

breaching when the manufacturer earns a net profit from sales before reputation

is devalued.”519 Multilateral reputation mechanisms do only deter a merchant

from breaching when “the specific investment required of the firm to enter the

market—its dedication of assets whose value would be sacrificed if the firm were

later excluded from the market—[is] so great that the firm suffers a net loss when

expelled from the market, even though the firm sells some defective [or

nonexistent] products before the market discovers the defect.”520 And although

the Internet might allow to disseminate information about past merchant behavior

more quickly than ever before,521 it lies in the nature of online transactions that

there often is simply no way that information will spread quickly enough to fully

avoid that online scams operate long enough to be profitable. That is, because in

most cases the defrauded consumer herself will not know that she has been

defrauded until a considerable amount of time has elapsed. A consumer, for

example, won’t realize that the goods she ordered will not arrive until a

reasonable time for shipping has passed. She won’t realize that her credit card

account has been unduly charged until she checks her monthly statement. So

even when one assumes (which is unrealistic) perfect and immediate information

of all other consumers by the first victim, the fraudster will profit from other




519
      See Charny, supra note 485, at 413.
520
      See id.
521
      Subject, of course, to the limitations indicated above. See supra II.C.2)b).

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victims during the time period until the first victim realizes that she has been

defrauded.



D.        From Compliance to Trust?

As has been shown above, reputation mechanisms can lead to a certain degree

of compliance, even to a relatively high degree of compliance—but not to a

perfect one. Unfortunately, however, a high degree of compliance will not lead to

a high degree of consumer trust, because whether a merchant will actually

comply and whether a consumer can reasonably expect a merchant to comply

are two different questions. When ninety-nine out of hundred merchants are

honest and only one is a fraudster, the consumer nevertheless will mistrust all of

them—unless she is able to tell who is who before taking the risk of entering into

a transaction. Thus, a small number of dishonest merchants can disrupt

consumer trust in the marketplace as a whole522 when consumers can’t

distinguish the (many) good guys from the (few) bad guys. Reputation

mechanisms therefore may lead to a high degree of compliance, but they are not

sufficient to produce consumer trust. Trust requires more than compliance by

merchants, it requires a link allowing consumers to expect compliance,523 and




522
   In similar contexts this is referred to as a nonidentification problem. See, e.g., Klein & Leffler,
supra note 484, at 617 n.3 (explaining that, when a particular but unidentified firm’s supply is
lower than the anticipated quality, future sales will be lost not only of that firm but of all firms in the
industry). See also Charny, supra note 485, at 442 (arguing that breach in one transaction may
make other transactors more uncertain about whether they can trust each other).
523
   Expectations about another’s uncertain future behavior have been identified above as being
essential to trust. See supra text following note 175.

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this link can depend on a number of different factors. The most important of

these factors are information, time, and investment.


1)          Information
Trust, exposition to a risk because of one’s positive expectations about another’s

uncertain future behavior,524 is typically based on information about the other’s

past behavior.525 Has this merchant complied in the past, were its customers

happy? From this information potential transactors will draw inferences and build

expectations as to future behavior.526 This is problematic in several regards.


Building trust based on past behavior is the flip side of the problem whether a

multilateral reputation mechanisms will induce merchants to self-enforce their

obligations. Both sides are subject to the same constraints: Consumers won’t

trust and merchants won’t comply unless the relevant information can be

disseminated and analyzed quickly, widely, cheaply, and accurately.527 Just the

amount of information available on the Internet is likely to lead to what has been

identified by Kenneth Arrow as an “efficiency loss due to informational




524
      For this definition of trust see supra text preceding note 167.
525
     See, e.g., LUHMANN, supra note 168, at 20, 33 (“[trust] needs history as a reliable background”;
“it rests on the truster ... being already informed, even if incompletely and unreliably”); GOVIER,
DILEMMAS OF TRUST, supra note 149, at 122-38 (discussing reasons for trust and distrust, the
most important of which being information, among other things, about past actions of a person);
GOVIER, SOCIAL TRUST, supra note 149, at 3 (“Trust presupposes beliefs, and often those beliefs
are based on evidence. The case of trusting people ‘immediately’ or ‘instinctively’ is a special
one, and even here we probably have evidence—we just do not reflect on what it is, or articulate
it.”)
526
    GOVIER, SOCIAL TRUST, supra note 149, at 3 (“If we know that someone has acted honestly on
five occasions, we have a great tendency to infer that she will act honestly on a sixth; ....”).
527
      See supra text following note 507.

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                     The Online-Marketplace: Shaking the Foundations of Consumer Confidence


overload.”528 Moreover, the consumer will not only face the problem of finding

and filtering out the important information, she will also have to face the problem

of verifying this information because never before has it been so easy to spread

false or misleading information. Note also, that this information will, by the very

nature    of    electronic     commerce        as    being     characterized      by    distance

transactions,529 typically not be based on the consumer’s direct personal

knowledge but on “media-based knowledge”.530 This raises a secondary trust

problem.531 Before a consumer can decide whether to trust a merchant, based on

the information available to her on that merchant’s past behavior, she will have to

assess whether to trust the source of information. And recall that the source of

information posted on the Internet is often not even identifiable. All this might

entail very high, given the stakes involved in consumer transactions often

prohibitive, transaction costs.532




528
   See ARROW , supra note 212, at 75. See also NORTH, supra note 143, at 25 (arguing that the
“computational limitations of the individual are determined by the capacity of the mind to process,
organize, and utilize information” and that from this “rules and procedures evolve to simplify the
process").
529
   See supra II.A. See also supra text accompanying note 190 (pointing out that an important
basis for trust—personal impression—is typically not available in the online context).
530
   See GOVIER, DILEMMAS OF TRUST, supra note 149, at 124-25 (discussing media-based and
knowledge arguing that it has a lower status than direct personal knowledge). See also supra
note 189. For the implications this has see infra note 619 and accompanying text.
531
    Cf. GOVIER, DILEMMAS OF TRUST, supra note 149, at 124 (“The issue of media-based
knowledge raises especially interesting questions of secondary trust: a judgment about the
trustworthiness of someone we know through the media is predicated on a tacit judgment of the
trustworthiness of the media themselves.”) (emphases added).
532
   We will see later (infra III.A) whether new information intermediaries can significantly lower
these costs.

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Furthermore, even if it is assumed that a consumer can efficiently get accurate

information on a merchant’s past behavior, this alone is a relatively weak basis

for trust. As has been shown above, “[t]he committing party will breach whenever

the benefits of breach out-weigh the cost of sacrificing the bond.”533 Put

differently, past behavior by itself does not really say a lot about future behavior.

A merchant might always have complied in the past but find at one point, that

now the benefits from breaching exceed the loss of future gains. This may be

because the life cycle of the product or service is about to end, because business

isn’t going so well in general, because the merchant has just complied so far to

establish a large enough customer base to get to the point where breaching

becomes profitable and so forth. The problem therefore is that the consumer may

well know about a merchant’s past behavior (being compliant), but without

additional information534 she will not know whether it is still efficient for the

merchant to be compliant in the future.


Finally, a consumer whose trust is disappointed will not be able to get any

redress. The reputation of a merchant might, subject to efficient information

dissemination, be ruined for the future preventing other consumers to engage

into transactions with that merchant and incurring a loss. But that does not help

the      consumer      who     generated      the    information   about   the   merchant’s




533
      See supra note 494.
534
      See infra text accompanying note 544.

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                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


untrustworthiness in the first place.535 This, of course, is simply the

materialization of the risk inherent to trust and the key factor that distinguishes

trust from reliance.536


2)          Time
Trust is subject to another constraint—time. Trust is built over time, based on a

learning process requiring information about past behavior.537 This process is, as

Luhmann points out, “only complete when the person to be trusted has had

opportunities to betray that trust and has not used them.”538 Therefore, building

trust cannot only be hindered by problems of disseminating and assessing

information on past behavior, but also by the lack of such information altogether,

because there is no past behavior. Especially companies just entering the market

will not have a prior record of successful or satisfying consumer transactions that

is necessary for consumers to build trust. Market entrants, in fact, will not have a

prior transaction record to point to at all. This becomes a major problem, when




535
    See also Charny, supra note 485, at 401 (“[N]onlegal sanctions may not provide ex post
compensation to the victim of the breach. For example, the manufacturer’s loss of reputation will
not benefit the purchaser of a defective product.”).
536
   LUHMANN, supra note 168, at 43 therefore emphasizes the need for an investment to start off a
trust relationship.
537
    See The Cheskin Research & Studio Archetype/Sapient, eCommerce Trust Study 3 (Jan.
1999),     available     at  <http://www.studioarchetype.com/cheskin/assets/images/etrust.pdf>
[hereinafter Cheskin Research, Trust Study] (characterizing trustworthiness as “a function of time
and specific formal characteristics of sites” and finding that “experience is a necessity for true
trust to develop”). See also Maryann Jones Thompson, E-commerce Spotlight: Building Trust
Online,              THE            STANDARD                (Jan.            25,            1999)
<http://www.thestandard.com/research/metrics/display/0,2799,9928,00.html> (referring to the
aforementioned study).
538
      See id. at 45.

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                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


reliance mechanisms fail as well,539 because these could enable exchange in the

absence of trust. Absent effective reliance mechanisms this problem of initial

trust becomes fully apparent. It creates a viscous circle for new merchants:

Without (initial) trust, merchants cannot build a good transaction history—and

without a good transaction history, consumers won’t build trust in these

merchants. Without a sufficient basis for trust it is not likely that any consumer—

by what would then be trusting blindly540—wants to be the first to put her

investment at risk (with no compensation in sight if the trust is breached). 541

Thus, given the failure of traditional reliance mechanisms, overcoming the

problem of initial trust is one of the greatest barriers for merchants to successfully

enter the online marketplace. Or, as has been said elsewhere, “[e]-business is

moving at the speed of light, but it is outpacing human time ... the time needed to

build trust.”542


3)          Investment and Branding
Given the problems of information and initial trust discussed above, two factors

become extremely important in gaining consumer trust: investment and branding.




539
      Which, as has been shown above, they do to a large extent in the online environment.
540
   See also GOVIER, SOCIAL TRUST, supra note 149, at 3 (referring to people whose trust is not
based on evidence as too trusting or gullible).
541
      See supra text accompanying note 535.
542
      PWC, E-Business, supra note 149, at 7.

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                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


As indicated above,543 setting up shop online typically requires a significantly

smaller up-front investment than doing the same thing offline. This is one reason

why the online marketplace is such an attractive place for scam artists. The

expenditures for honest merchants might be higher than for fraudsters—

depending on the goods or services offered—since they eventually need to get

and store supplies, rent storage facilities etc. However, even where online

merchants incur these costs, it is typically not visible to customers. This accounts

for one important difference between online and offline shops. Offline the

customer can get a personal impression of the physical location which had to be

rented, the goods that are displayed etc.544 All this conveys additional information

to the consumer, namely information about a merchants initial investment or its

sunk costs. This information is important in regard to the above finding that self-

enforcement of contracts will fail, when the benefits of breaching and reaping a

short-run profit outweigh the costs of sacrificing potential future profits from

repeated transactions.545 A firm’s initial investment plays an important role in this

equation. The higher the sunk costs at the beginning, the more the merchant

becomes dependant on an anticipated future revenue stream from repeated

dealings because breaching and pulling out of the market will overall not be

profitable unless the sunk costs of setting up the venture have been recovered.

Thus, a consumer’s knowledge about a merchant’s sunk costs will strengthen her




543
      See supra note 114 and accompanying text.
544
      See also supra note 29 and accompanying text.
545
      See supra note 494.

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                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


trust in that merchant’s compliance.546 Online, however, there will either be next

to no investment in physical assets at all or information about such an investment

will not be visible for consumers.547 Nevertheless, there are other ways of

”buying” trust that also work in the online world, namely expenditures on

advertising and establishing a well known brand name.


Klein and Leffler have shown that “brand-name capital” investments (for example

sunk investments in the design of a firm logo or an expensive sign promoting the

firm’s name) can serve as a hostage to prevent a merchant from cheating.548

They argue that advertising supplies valuable information to consumers, most

importantly the information “that the firm is advertising”.549 Advertising,

information about past advertising, or the publication of large fees paid to

celebrities for commercials,550 inform consumers551 about the magnitude of sunk

capital costs. If the investment is sufficient, it “implies that a firm will not engage



546
      This is the additional information referred to supra text accompanying note 534.
547
    Some investments in the “shop”, however, may also be visible online. This includes
expenditures on a sophisticated design of the site, expenditures on cutting edge technology
leading to fast and reliable accessibility etc. This explains why easy navigation, professional
presentation, and state of the art technology have been found to be among six primary
components communicating trust online. See Cheskin Research, Trust Study, supra note 537, at
9.
548
      See Klein & Leffler, supra note 484, at 626.
549
      See id. at 630.
550
    Note that a number of online companies meanwhile use celebrity endorsed commercials, for
example: William Shatner (Priceline.com), Cindy Crawford (babystyle.com), Whoopi Goldberg
(Flooz.com), Anna Nicole Smith (E*Trade), Picabo Street, Anna Kournikowa (Charles Schwab),
Geena Davis, Jackie Chan, Phil Jackson (TD Waterhouse), Shaquille O’Neal, Tiger Woods,
Michael Jordan (SportsLine), Sammy Sosa (OneNetNow.com). See Toni Logan, Lights! Camera!
Stock Options! Celebrities help ebusinesses build brand, but can star power substitute for an
integrated marketing strategy?, BUSINESS 2.0, April 2000, at 165.



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                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


in short-run quality deception since the advertising indicates a nonsalvageable

cost gap between price and production costs”.552 In other words “consumers

know that such sunk costs can be profitable only if the future quasi rents are

large.”553 And if consumers estimate that the initial sunk expenditure is greater

than the short-run cheating gain, “then a price premium on future sales sufficient

to prevent cheating is estimated to exist.”554 In short, if a company spends

enough on advertising and building a brand, consumers can be confident that

this company will not be going for the short-run profit by cheating—simply

because it doesn’t pay.


Thus, by making a large enough investment (i.e. by “sinking” enough costs) up-

front, companies can “buy” consumer trust. More importantly, the company can

buy initial trust. It doesn’t need a good record of prior transactions for this formula

to function. The “classic” example of an online merchant that took this route is

Amazon.com.555 Revenues grew from $15.7 million in 1996 to $1.6 billion in

1999. The fact that Amazon.com still reported a net loss that went up from $5.8

million in 1996 to $719 million in 1999 is partly due to extensive expenditures on

branding and advertising556 to build a loyal customer base.557 These efforts have



551
    Klein & Leffler explicitly state that they “do not want to claim that consumers ‘know’ this theory
in the sense that they can verbalize it but only that they behave in such a way as if they recognize
the forces at work.” See id. at 634.
552
      See id. at 630.
553
      See id. at 631.
554
      See id.
555
      See http://www.amazon.com.
556
      See Robert Spector, Going for Broke, BUSINESS 2.0, April 2000, at 256, 262.

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                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


obviously been successful since Amazon is found to be one of the best known

and, more importantly, one of the most trusted web brands.558 The customer

base grew from 180,000 in 1996 to 17 million in 1999.559 Amazon’s core

segments—music,             DVD/video,       and       books—have        meanwhile       achieved

profitability, and the company as a whole is expected to be profitable by 2002.560


It is therefore not surprising that several studies on online commerce mention a

company’s brand as one of the most important factors in the process of building

trust.561 The most trusted brands have been found to all be well-known brands,562

implying considerable capital investment in building the brand and making it well

known.


Given the importance of a well-known brand it is also clear that existing bricks

and mortar stores that already have established a brand and a reputation can

have an important advantage as they go online and evolve to clicks and mortar

stores. The finding that “brand matters more than medium” which is underlying

the argument that well known e-brands could now also successfully operate in




557
    Richard Richtmyer, Amazon beats the Street: Online retailer sneaks past estimates; sees
narrower         operating        losses,      CNNfn          (April       26,        2000)
<http://cnnfn.com/2000/04/26/technology/amazon>.
558
      See Cheskin Research, Trust Study, supra note 537, at 20.
559
      It is reported to have reached 20 million as of March 31, 2000. See Richtmyer, supra note 557.
560
      See id.
561
   See PWC, E-Business, supra note 149, at 10; Cheskin Research, Trust Study, supra note
537, at 9. See also DIGITAL ECONOMY I, supra note 4, at 25 (“Building brand awareness through
advertising and marketing is critical to success in a new and rapidly evolving market, ....”).
562
   See Cheskin Research, Trust Study, supra note 537, at 20 (listing the 12 most trusted brands,
starting with Yahoo!, Wal-Mart, and Netscape).

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                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


the physical world,563 is also true in the opposite sense. Offline stores can

leverage their existing reputation online.564 An offline presence further implies

visible tangible assets (and investments in those) which are an additional factor

in the process of building trust.565 Consequently studies suggest that five of the

twelve most trusted brand names in e-commerce originate offline (including Wal-

Mart, Blockbuster Video, USA Today, and Dell), while none of the least-trusted

sites does.566


Another survey showed that 39% of all users and 46% of new users (being online

for less than a year) are generally more likely to shop from merchants they have

bought from offline.567 In other words, offline companies have already made the

investment in branding and advertising that is important to overcome the problem

of initial trust. Moreover, because they do have a physical and visible presence,

other bases for trust and reliance become more important. These factors include

the existence of and possibility to actually reach tangible assets, the possibility of

getting a personal impression, or the greater difficulty of escaping law

enforcement. Thus, the absence of anonymity, mobility, and globality—

characteristics of the online world—in the offline world makes it generally easier



563
      See id. at 30.
564
   See PWC, E-Business, supra note 149, at 23 (“[C]ompanies that have made good on their
promises, that do have strong track records on Main Street and in cyber-space, are the ones that
can move forward into cutting-edge areas. They proceed, confident of drawing interest because
they have developed a measure of trust over the years that will stand them in good stead as
innovative measures are undertaken online.”).
565
      See supra text accompanying note 547.
566
      See Cheskin Research, Trust Study, supra note 537, at 4, 20.
567
      See Guglielmo, supra note 123 (citing a survey by Jupiter Communications).

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                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


to establish consumer confidence offline. When going online, initial trust is not a

problem for these companies. Pure online merchants, however, start from

scratch in the new environment. They do face the problem of initial trust and can

not rely on these other factors to overcome it. Expenditures on branding and

advertising therefore become relatively more important to build initial trust.


Once the barrier of lacking initial trust is overcome, be it offline or by means of

“sinking costs” online, the vicious circle is broken up. The company now has the

chance to build a track record. Consumers will make experiences, and a history

of successfully completed transactions can develop.568



E.          Who Gets Left Behind?

Building trust online is more difficult than offline—but it is obviously possible.

Why, then, can’t it all be left to the market—apart from the fact that almost

everybody, including the market participants, agrees569 that the lack of consumer

confidence is one of the greatest barriers for electronic commerce to reach its full

potential?


Given the above findings it is apparent that traditional reliance mechanisms—to

the largest extent—do not work online. Regarding trust, the biggest problem is an

inherent lack of initial trust. Adding these two findings together implies that, in the

extreme, consumers avoid transactions with new and unknown online merchants



568
      See PWC, E-Business, supra note 149, at 10.
569
      See supra notes 13-21 and accompanying text.

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                     The Online-Marketplace: Shaking the Foundations of Consumer Confidence


altogether. The problem of initial trust can be overcome if a bricks and mortar

company can leverage its offline brand to the online environment, or if an online

company can afford high expenditures on advertising and branding to inform

consumers of a significant amount of sunk costs and thus give them a

reasonable basis to trust in subsequent compliance by that company, because it

needs to recover these losses by establishing repeat-dealing relationships with

customers.


So who gets left behind under these conditions? For once, those merchants get

left behind that do not have a well known offline brand, that do not have the

financial means to make enormous up-front investments in branding and

advertising, and that cannot afford to lose money for 6 to 7 years before

eventually becoming profitable. Recent developments show, that an increasing

number of companies do not have the long (financial) breath required to take the

route of “buying trust” over an “amazonian” period of about 7 years before

producing black numbers on their balance sheet. As more and more online

retailers or e-tailers run short on cash because sales are lower than expected

while “[a]t the same time, they’ve poured millions of dollars into expensive

advertising campaigns in a desperate attempt to establish brand names”,570

public investors as well as venture capitalists are getting more skeptical.571




570
  See also Joelle Tessler & Matt Marshall, Online firms short on cash, SAN JOSE MERCURY
NEWS, April 1, 2000, A1.
571
    See id. (citing Lior E. Yahalomi of CMGI@Ventures.com, a venture capitalist specializing in
Internet companies, as saying that fewer business-to-consumer Internet companies are meeting
the more stringent investment criteria that his firm is now using).
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                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


New market entrants that cannot leverage an offline reputation or “buy” online

trust, however, are trapped in the vicious circle described above: Absent effective

reliance mechanisms they absolutely depend on a record of prior transactions as

a basis for consumer trust—without already having established trust, however,

consumers will not engage in transactions with the merchant in the first place.

The lack of (initial) consumer confidence thus creates a high entry barrier for new

merchants, particularly for small and medium sized enterprises (SMEs).572 Less

than one third of SMEs with a web presence573 are using their sites to sell

products, provide customer support, or reduce operating costs.574 Exactly these

enterprises, however, are frequently believed to play a crucial role in the further

development of electronic commerce.575 Vice president Al Gore even asserts

“that small and medium-sized enterprises, and their rapid adoption of e-

commerce, are crucial to our continued economic success.”576 Facilitating small

business participation in electronic commerce therefore has been an explicitly




572
   This fact is overlooked by OECD, supra note 464, at 39 (asserting that “[t]he Internet has
made it easier for both SMEs and individuals to enter the marketplace, as they need neither
physical shops nor sales offices”).
573
   A survey by The Yankee Group finds that 28% of companies with less than 20 employees,
54% of companies with between 20 and 99 employees, and 62% of companies with between 199
and 499 employees maintain a web presence, see W ORKING GROUP II, supra note 4, at 25 n.29.
574
      See id.
575
   See generally OECD, Directorate for Science, Technology and Industry, Industry Committee,
Working Party on Small and Medium-Sized Enterprises, SMEs and Electronic Commerce,
DSTI/IND/PME(98)18/REV1                        (Sept.             18,                 1998)
<http://www.oecd.org/dsti/sti/it/ec/prod/sme18e.pdf>.
576
      See W ORKING GROUP II, supra note 4, at ii.

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stated policy goal in the U.S. as well as in Europe.577 Without establishing initial

consumer confidence, however, the achievement of this goal seems endangered.


In addition to the entry barriers for SMEs, the few (larger) companies that could

leverage their offline brand or successfully made high investments in establishing

their online brand get a double advantage. They can overcome the lack of initial

trust and, now getting the chance to engage in repeated transactions, they can

build a positive track record and ultimately a good reputation. Once having made

a good experience with an online merchant, customers are likely to come back to

that merchant instead of taking the risk of trying out a new merchant. According

to a survey 37% of customers will favor merchants they have bought from

before.578 Other findings suggest an even higher percentage of returning

customers. Repeat-customer orders, for example, represented 76% of Amazon’s

total orders in the first quarter of 2000.579 This suggests that the first-mover

advantage of those overcoming the initial trust problem is becoming more

important than ever.




577
     See id. at iv, 26-28 (describing various initiatives of the U.S. Department of Commerce and
other agencies to assist small companies in the use of electronic commerce); A European
Initiative in Electronic Commerce, supra note 16, at 4 (“Electronic commerce presents enormous
potential opportunities for consumers and for businesses in Europe, particularly for SMEs.”)
(emphasis added) (continuing to describe the particular importance of SMEs and special
programs to support SMEs involvement in e-commerce throughout the document).
578
      See Guglielmo, supra note 123 (citing a Jupiter Communications research).
579
      See Richtmyer, supra note 557 (this number is up from 66% during the same period in 1999).

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                        The Online-Marketplace: Shaking the Foundations of Consumer Confidence


The big get bigger and the small will have an increasingly harder time to enter

the market and compete. This does not only effect pure online companies, 580 but

also small offline merchants. The latter are in a dilemma. For the reasons

described above they will have a hard time entering the electronic marketplace,

and—imagine a small book shop—they increasingly run the risk to lose market

share against online retailers like Amazon, because people find it more

convenient to shop online. It has been noted before, that the brand now often

matters more than the medium,581 meaning online companies are also competing

with their offline counterparts. Therefore, “[b]y not making the transition to this

new way of doing business, small firms run a serious risk of becoming less

competitive, affecting both their present market positions and long-term

viability.”582 Given a lack of initial consumer confidence, however, making that

transition is not all that easy.


Besides SMEs and market entrants with modest financial means, consumers

may get left behind to some extent as well. In the situation just described, the

diversity of the market may suffer, ultimately limiting the consumer’s choice. If

you, for some reason, do not want to buy your books at Amazon but the

bookstore at the corner, you might find that the store did not make it, neither

online nor offline. The whole idea of the Internet making possible a highly diverse



580
    For an example see Tessler & Marshall, supra note 570 (“The company [CDNow] has been
struggling ever since Amazon.com began selling music online in the summer of 1998 and quickly
became the largest music retailer on the Web.”).
581
      See supra note 563.
582
      W ORKING GROUP II, supra note 4, at 25.

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                   The Online-Marketplace: Shaking the Foundations of Consumer Confidence


market where everybody—large companies, SMEs, or individuals—can be a

buyer and a seller and transactors find the best match each time, stands and falls

with the existence of initial confidence. Without it, consumers will have no choice

but to become repeat customers, always coming back to the few companies that

could overcome the initial trust barrier. Trying other (new or small) companies

and their products and services will remain a risky business, meaning that a

number of consumers will refrain from doing it although they might get a better

deal if the transaction was successful.


Finally, even where companies can overcome the problem of a lack of initial

trust, for example by making high up-front expenditures on branding and

advertising, the consumer’s position remains rather weak. Trust relationships, no

matter on which bases the trust is grounded, always remain risky. This aspect

distinguishes trust from reliance.583 If the consumer’s trust is breached, the

merchant might face a loss of reputation, but the individual consumer won’t be

able to get redress.584 To some extent, therefore, the trusting consumer is always

at the merchant’s mercy. Ultimately it is the merchant who decides when

breaching the consumer’s trust is efficient. Even with a stronger basis for trust,

like high initial sunk costs, the consumer depends on the merchant getting his

economics right. When it is clear that the business, despite—or because—the

high initial investment will never be profitable, the merchant can play an end

game and try to at least reap all the short-run profits it can by cheating.




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                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


F.          Summary—The Need for New Institutions

To serve as a basis for consumer reliance, enforcement mechanisms must be

actually effective, cheap, and quick. Moreover, they must be able to guarantee a

consumer individual redress if things go wrong and they must be available upon

the consumer’s own initiative. The above analysis has shown that traditional

enforcement mechanisms as currently employed generally don’t meet these

requirements. Litigation is too expensive. State enforcement will be ineffective to

a certain extent because of problems in detecting fraudulent behavior, tracking

the person behind it, and reaching this person or assets within the jurisdictional

boundaries of the enforcement agency. Moreover, criminal sanctions—as

organization enforcement—will not lead to redress of an individual defrauded

consumer. Further, all third party enforcement mechanisms (criminal sanctions,

FTC actions, and organization enforcement) are not initiated by the consumer.

The consumer depends on the third party to make the decision to bring an

enforcement action. This decision depends on a variety of factors beyond the

consumer’s control (costs, feasibility, prospective of success, magnitude of

damage, etc.). Thus, even where consumer redress is theoretically possible (as

in FTC actions), these mechanisms remain a very weak basis for an individual

consumer’s confidence that things can be fixed for her if they go wrong.




583
      See supra notes 175, 198 and accompanying text.
584
      See supra note 536 and accompanying text.

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                       The Online-Marketplace: Shaking the Foundations of Consumer Confidence


The second basis of consumer confidence—trust—faces its limits as well. It is

subject to significant constraints regarding availability, verification, and

assessment of information. To some extent these information deficiencies can be

overcome by high investments of merchants, but this option clearly is not

available to everyone. Trust also has other limits of a more general nature. Most

importantly, the consumer is always left at the merchant’s “mercy” to the extent

that the merchant is likely to breach the consumer’s trust the moment it becomes

more efficient than living up to it. The information asymmetries in regard to the

factors determining that decision are typically even larger.


This situation suggests a need for new institutions585 that enable and facilitate

building consumer confidence by overcoming the problems identified above. The

types of new institutions that emerge or could emerge and the ways in which




585
     See also NORTH, supra note 143; at 33 (“[W]ithout institutional constraints, self-interested
behavior will foreclose complex exchange, because of the uncertainty that the other party will find
it in his or her interest to live up to the agreement.”), 34 (stressing the need for reliable institutions
that allow individuals to engage in complex contracting); BAIER, supra note 496, at 189
(Discussing and restating Hume’s argument for the need of institutions: “Only when magistrates
are invented to receive complaints and to keep official track of a person’s record can persons in a
large society count on a promise-breaker being generally know as such, and/or effectively
punished.”). See generally OLIVER E. W ILLIAMSON, THE ECONOMIC INSTITUTIONS OF CAPITALISM
163-205 (1985) (discussing institutions and “credible commitments”).




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                     The Online-Marketplace: Shaking the Foundations of Consumer Confidence


these institutions try to enhance consumer confidence will be discussed in the

following section.




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                            Enhancing Consumer Confidence: The Rise of New External Institutions




III.        ENHANCING CONSUMER CONFIDENCE: THE RISE OF NEW
            EXTERNAL INSTITUTIONS

In the literature the role of institutions has been emphasized both for overcoming

information problems586 and providing third-party enforcement.587 Simple

reputation mechanisms, for example, require keeping every transactor

completely informed about everybody else’s past behavior.588 While this was

possible within small, homogenous groups engaging in local trade,589 it quickly

becomes too costly in regard to large-scale impersonal exchange.590 It becomes

too costly unless institutions, namely information intermediaries, can significantly

mitigate the information costs.591


Others assert that in complex societies engaging in large-scale impersonal

exchange, neither self-enforcement nor trust can be completely successful and a

coercive third party that enforces agreements is essential.592




586
   See, e.g., Milgrom et al., supra note 434, at 2 (“[W]hat role do formal institutions play when
simple reputational mechanisms fail?”).
587
   See, e.g., NORTH, supra note 143, at 58 (“[V]iable impersonal exchange that would realize the
gains from trade inherent in the technologies of modern interdependent economies requires
institutions that can enforce agreements by the threat of coercion.”).
588
      See Milgrom et al., supra note 434, at 3. See also supra note 503.
589
   See, e.g., NORTH, supra note 143, at 34 (“personalized exchange involving small-scale
production and local trade"). See also supra note 501.
590
   See Milgrom et al., supra note 434, at 3 (“In a large community ... it would be too costly to
keep everyone informed about what transpires in all trading relationships, ....”).
591
      See supra note 513 and accompanying text. See also Milgrom et al., supra note 434, at 7.
592
      See NORTH, supra note 143, at 35.

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                             Enhancing Consumer Confidence: The Rise of New External Institutions


Both approaches, self-enforcement as a basis for trust and third-party

enforcement as a basis for reliance, in their traditional forms have been shown to

not meet the needs of the online marketplace—the classic example for large-

scale impersonal exchange. Both approaches, however, using new mechanisms,

attempt to overcome the problems and adapt to the online environment. Thus,

one can observe the emergence of new institutions that ultimately aim at

fostering trust, namely information intermediaries, and new institutions trying to

provide effective third-party enforcement and foster reliance.593 Recalling the

economics of trust and reliance discussed above,594 the central question

becomes which of these approaches can enhance consumer confidence—if at

all—more efficiently.



A.          New          Institutions          to       Foster        Trust—Information
            Intermediaries

The institutions that try to make bi- and multilateral reputation mechanisms work

in the online environment595 are information intermediaries. A multitude of

different approaches can currently be observed in the market. The intermediaries

typically convey information about merchants that is supposed to serve as a




593
  See also Heckman, supra note 113, at 2.8 (emphasizing that “[i]ntermediaries may also
emerge as the answer for enabling consumers to recover damages”).
594
      See supra II.B.1)c).
595
      See supra notes 514, 532 and accompanying text.

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                             Enhancing Consumer Confidence: The Rise of New External Institutions


basis for consumers to establish trust.596 Most of these approaches, however,

face similar limits.


1)           The Approaches
Information intermediaries that provide information on online merchants and their

business practices to assess their trustworthiness are numerous. Listings of

“selected” reliability programs, issuers of seals of approval, or rating services

include more than 75 such services,597 and new ones seem to appear daily.598

The following will provide an overview on some of the better known services.


a)          BBBOnline Reliability Program

The Better Business Bureau offers an online reliability seal program “to help web

users find reliable, trustworthy businesses online, and to help reliable businesses

identify themselves as such.”599 Merchants who want to use the BBBOnline

reliability seal must meet certain standards.600 They will have to become a

member of the Better Business Bureau, provide the BBB with information

regarding company ownership and management and its physical address (which



596
      See supra II.D.1) for the role of information in the process of building trust.
597
     See Alliance for Global Business, supra note 17, at 42-84 (listing and comparing selected
initiatives). See also Cheskin Research, Trust Study, supra note 537, at 16 (listing the 27 security
brands “that matter most”). See also W ORKING GROUP II, supra note 4, at 12 (describing seal
programs such as BBBOnline and CPA WebTrust).
598
   A more recent occurrence, for example, is PriceWaterhouseCoopers’ BetterWeb Seal that
costs a merchant $15,000 per website per year. See PriceWaterhouseCoopers, The BetterWeb
Program (visited Aug. 17, 00) <http://pwcbetterweb.com>.
599
         See    BBBOnline,      Reliability      Program      (visited             Aug.   17,   00)
<http://www.bbbonline.com/businesses/reliability/index.html>.
600
   See BBBOnline, Standards for BBBOnline Reliability Program Participation (visited Aug. 17,
00) <http://www.bbbonline.com/businesses/reliability/standards.html>.
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will be verified by the BBB), they must be in business for a minimum of one year,

they must have a satisfactory complaint handling record with the BBB, they must

agree to participate in the BBB’s advertising self-regulation, and they must agree

to dispute resolution at the consumer’s request. The BBB, however, explicitly

notes that it does not guarantee that customers will be satisfied with the

merchant’s product or service, or that the merchant never experienced

complaints or will so in the future. The BBB does not pre-clear or pre-approve

any advertising of the participants, nor does it engage in active monitoring or

bring enforcement actions if a merchant violates the BBB standards. Annual fees

for participating merchants range from $100 to $3000 depending on the size of

the company.


b)          CPA WebTrust

The American Institute of Certified Public Accountants and the Canadian Institute

of Chartered Accountants issue the CPA WebTrust seal601 because “it’s difficult

to judge a company’s honesty and integrity simply by looking at a website.” 602 To

get the seal, the company’s website is examined by a specially licensed certified

public accountant (CPA) who will, among other things, evaluate its business

practices, including order processing, and handling of returns, warranties, and

other problems. The business practices must meet the standards set forth in the

CPA WebTrust Principles and Criteria for Business-to-Consumer Electronic



601
      See CPA WebTrust (visited Aug. 17, 00) <http://www.cpawebtrust.com>.
602
       CPA    WebTrust,    It’s  a    Matter    of       Trust    (visited   Aug.    17,   00)
<http://www.cpawebtrust.com/consumer/index.html>.
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Commerce.603 These principles require, among other things, that the company’s

management maintains effective controls to provide that customers' orders

placed were completed and billed as agreed.604 To keep the seal the site must be

re-audited by a CPA every ninety days and show that it is in conformity with the

WebTrust standards.


PriceWaterhouseCoopers’ BetterWeb Program operates in a quite similar

manner.605 The fee for the BetterWeb seal is $15,000 annually.


c)          Bizrate, eComplaints, and e-Rating

Bizrate.com,606        eComplaints.com,607         and      Consumer         Reports      Online’s

e-Ratings608 take a slightly different approach from the seal programs discussed

above.


Bizrate is ranking online merchants according to their performance ratings by

actual customers. The information includes the buying process itself and whether

the delivery arrived on time and met the customer’s expectations. Customers,




603
   See American Institute of Certified Public Accountants, Inc. & Canadian Institute of Chartered
Accountants, Web Trust Principles and Criteria for Business-to-Consumer Electronic Commerce
(Oct. 15, 1999) <http://www.aicpa.org/webtrust/princritb.htm>.
604
    For a detailed list of the Criteria the company has to demonstrate that it is conformity with see
id. <http://www.aicpa.org/webtrust/wtpcbprinc.htm>.
605
      See supra note 598.
606
      See <http://www.bizrate.com>.
607
      See <http://www.ecomplaints.com>.
608
      See <http://www.consumerreports.org>.

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                           Enhancing Consumer Confidence: The Rise of New External Institutions


according to a list of ten criteria regarding the merchant’s business practices,609

then rate the stores. Bizrate thus is a typical information intermediary that collects

and aggregates customers’ information on past transactions. 610


Ecomplaints.com collects consumer complaints about companies based on the

consumers’ own experiences and publishes them on the web “to provide

information to potential consumers before they purchase a product or service in

order to reduce their own risk”.611 Shoppers are encouraged to “stop in at

eComplaints.com and read the complaints other consumers have issued” before

they buy.612


Consumer Reports Online does not rely on customer information for its

e-Ratings, but it frequently evaluates sites on its own by approaching them “as

an average customer would.”613 The store is then rated according to a checklist,

which includes policies, usability, and content. The ratings are only accessible for




609
     See Bizrate.com, About BizRate.com—Store               Ratings   (visited   Aug.   17,   00)
<http://www.bizrate.com/inside/ratings.xpml>.
610
   Ebay’s Feedback Forum takes a similar approach in the consumer-to-consumer environment.
See        Ebay,     The       Feedback       Forum      (visited    Aug.     17,     00)
<http://pages.ebay.com/services/forum/feedback.html>.
The idea is also quite similar to institutions that have evolved to overcome information problems
regarding medieval champagne fairs and that have been studied by Milgrom et al., supra note
434. In both cases “each individual possesses direct information solely about his own past trading
experiences.” (See id. at 9). The law merchant system that has developed in response to that
(each transactor shared her information with a private judge who also serves as a repository for
information, see id. at 10) is, in fact, an early example of a feedback forum.
611
      See eComplaints.com (visited Aug. 17, 00) <http://www.ecomplaints.com/About/about.php3>
612
      See eComplaints.com (visited Aug. 17, 00) <http://www.ecomplaints.com/index.php3>.
613
    See Consumer Reports Online, e-Ratings Online Shopping Guide (visited Aug. 17, 00)
<http://www.consumerreports.org/Special/Samples/Reports/0001erat.htm>.

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                            Enhancing Consumer Confidence: The Rise of New External Institutions


subscribers.614 In principle, Consumer Reports Online’s approach is not much

different from Bizrate’s except that the former generates its own information

about a specific merchant while the latter relies on information provided by

customers.


2)          The Limits
The most obvious limit of all of the approaches described above is that they

cannot overcome the problem of lacking initial trust. Information intermediaries

generally depend on existing information about merchants’ past transactions.

This is the reason why BBBOnline requires a merchant to be in business for at

least a year before it can be considered for the reliability seal. CPA WebTrust

requires merchants to make representations that can be verified regarding a

period of 2 to 4 months preceding the application. Rating and feedback services

by their very nature rely on customer information about their transaction

experience with a merchant. Consumer Reports Online is an exception in this

respect because it generates information on its own by engaging in test-

transactions.


Another problem is that the sheer mass of seal programs and rating services615 is

likely to confuse consumers. Surveys have shown that, for example, only 18% of

users are familiar with BBBOnline and that even less, 8% of users, are familiar




614
      The rate is $3.95 per month or $24 per year.
615
      See supra note 597.

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with Bizrate.616 It has been found that “security brands” are generally not well

known to consumers.617 This situation aggravates the secondary trust problem

briefly addressed above.618 A consumer will not trust a seal that she does not

even know. So first, she would have to establish trust in the intermediary

providing the seal, which entails information costs. And the more seals and

ratings there are, the greater is the danger of dilution. Moreover, different

programs have different standards and verification procedures. Ecomplaints or

Bizrate, for example, apparently do not verify the information that users give

them.619 Thus, the whole problem of wrong or contradicting information on the

net is not solved and the consumer hardly has a meaningful basis for assessing

a merchant’s trustworthiness. A consumer would first have to educate herself as

to the different standards, controls, or enforcement mechanisms employed by a

particular intermediary. She needs to ask herself whether she can trust this site

and whether she can trust this seal. The information problem is just transferred to

another level.


And even if a consumer does rely on a specific service, all of the mechanisms

discussed above still entail significant transaction costs. Services like Bizrate or

eComplaints rely on consumers reading through the complaints or ratings before

they shop. This takes time and makes the buying process cumbersome.



616
      See Cheskin Research, Trust Study, supra note 537, at 16
617
      See id. at 15.
618
      See supra note 531 and accompanying text.
619
   See also supra notes 189, 530 (discussing media-based knowledge as opposed to direct
personal knowledge).
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                           Enhancing Consumer Confidence: The Rise of New External Institutions


Presumably buyers would prefer not to read through numerous complaints of

other customers about a particular merchant (not even knowing whether these

complaints are true or not) before making the decision to engage in a transaction

with that merchant. Thus, it is likely that they stick with the merchants they know,

with the well-known brands. It has been observed elsewhere that “[p]eople will

make seemingly irrational choices because the costs of acquiring better

information outweigh the benefits they expect from it” and that “[i]t is not rational

for people to be ‘rational’ about every single choice they make in life; if this were

true, their lives would be consumed in decisions over the smallest matters.”620

Thus, if it can be avoided, a consumer would rather shop without having to look

through what others have said about the merchant she is about to shop with. The

same is true in regard to acquiring information about a trust seal displayed on a

merchant’s site. Seal programs entail yet other transaction costs. Auditing and

frequent re-auditing of websites and business practices by a certified public

accountant or a consultant is expensive. An annual fee of $15,000, for example,

does not seem to be a negligible expenditure for a small enterprise trying to get

online.


Finally, despite all the seals and ratings the risk that the merchant will defect in

the future remains. This risk is inherent to any transaction based on trust621 and




620
      FUKUYAMA, supra note 145, at 20.
621
      See supra note 535 and accompanying text.

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                             Enhancing Consumer Confidence: The Rise of New External Institutions


is to be included in the costs of trusting when they are compared to the costs of

reliance on (effective) enforcement mechanisms.622



B.          Reliance on New Enforcement Institutions—The Crucial
            Role of Payment Intermediaries

The limits of using information intermediaries to foster trust and the costs this

approach entails suggest looking at another alternative. If establishing trust is too

expensive and the risks that remain are too great,623 one could turn towards

enhancing reliance instead. Since consumer confidence will follow from both trust

or reliance, the more efficient of the two should be chosen. The structure of

online transactions reveals an enforcement approach that might be effective and

significantly less costly than the attempts to enhance consumer trust while, at the

same time, it could guarantee initial consumer confidence regarding any

transaction without the need for any information on that particular merchant.


This approach addresses payment intermediaries. Due to the nature of online

transactions as distance transactions, which precludes an on-the-spot exchange

of the goods or services provided by the merchant and the customer’s

consideration, all of these transactions involve a payment intermediary. This can

be a credit card issuer, a bank that has to clear a check, or an e-cash or




622
      See supra II.B.1)c).
623
    NORTH, supra note 143, at 35 suggests that “neither self-enforcement by parties nor trust can
be completely successful” and that, since “the returns on opportunism, cheating, and shirking rise
in complex societies”, a “coercive third party is essential.”

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                           Enhancing Consumer Confidence: The Rise of New External Institutions


cybercash provider.624 The payment intermediary has an important middle

position in the transaction. The market has recognized this key role of payment

providers in the context of efforts to enhance consumer confidence and a variety

of services have developed that try to leverage this position. Legislators,

particularly outside the U.S., so far have recognized the strength of chargeback

mechanisms only to a limited extent. If they want to foster consumer confidence

in the electronic marketplace, this paper argues that they should employ

chargeback obligations as a means of enforcement of consumer rights more

broadly.


1)          Market Approaches
Several market approaches currently make use of the crucial role of payment

providers described above. Their objective is to mitigate the risk of prior

performance and to overcome the lack of effective enforcement of consumer

rights by affording quick, cheap, and easy redress to consumers if things go

wrong.


a)          Escrows

The first group of services that specifically address the risk of prior performance

normally born by the consumer, are escrow services such as escrow.com625 or

iescrow.com.626 The goal of these services is to “reduce the risk of fraud for



624
      See supra note 95 for an overview on online payment systems.
625
      See <www.escrow.com>.
626
      See <www.iescrow.com>.

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                        Enhancing Consumer Confidence: The Rise of New External Institutions


parties buying or selling merchandise from each other over the Internet” and to

“ensure buyers get what they pay for.”627 Basically, a third party—the escrow

service—receives the buyer’s payment, verifies it, and holds it in escrow until the

buyer has received and inspected the merchandise. If the buyer is satisfied, the

escrow service releases the payment to the seller.628 If the buyer is not satisfied

the escrow service releases the payment back to her, once the seller has

received the returned merchandise. Both parties must register with the escrow

service and enter into an escrow agreement before the transaction. The escrow

fee normally ranges between 1% and 4% of the value depending on its

magnitude and the payment mechanism used.629


These services, at the cost of needing to register, making an additional

agreement, and paying the escrow fees, overcome the lack of initial confidence.

The consumer’s risk is mitigated because she gets her money back (less the

escrow fee, of course) if the merchandise is not delivered as agreed upon. In the

words of iescrow.com the service can “allay fears of buyers wary of unknown

sellers”630 and thus overcome the problem of limited brand awareness for those




627
      See id.
628
        See     escrow.com,      The     Escrow      Process     (visited Aug. 17, 00)
<http://www.escrow.com/overview/index.html>. See also iescrow.com, Financial Questions
(visited Aug. 17, 00) <http://www.iescrow.com/finfaq.html#cost>.
629
    See escrow.com, Escrow Fee and Transaction Management Fee (visited Aug. 17, 00)
<http://www.escrow.com/help/fees.html>.
630
     See iescrow.com, The Smart          Way   to   Shop   Online   (visited   Aug.   17,   00)
<http://www.iescrow.com/service.html>.

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                           Enhancing Consumer Confidence: The Rise of New External Institutions


who do not have the funds to “buy” consumer trust with high investments in

branding.631


b)          “Blue,” Shopping Guarantees, and Insurance

Another approach is Blue from American Express.632 Blue is a credit card with

“special online features.” These include an “online shopping guarantee”, which

means that Blue users who use the card online will not be held responsible for

any unauthorized charges.633 The return protection allows users to return any

item they bought online even if the merchant won’t take it back—American

Express will refund the user up to $300 per item and $1000 per year. These

guarantees and protections obviously aim at fostering consumer reliance in the

electronic marketplace.


Online shopping insurance policies pursue the same goal. Ebay users, for

example, benefit from ebay’s free insurance for any item up to $200.634 The

insurance will cover losses resulting of payment for an item that is never received

or that is less than what is described. The German Insurance Company

Gerling635 is offering something similar. Its e-commerce insurance covers the risk




631
      See supra II.D.3).
632
       See    American    Express,   You’ve    Got   Blue          (visited   Aug.     17,    00)
<http://home4.americanexpress.com/blue/card_home.asp>.
633
    It is not really clear, however, what “unauthorized” means in this context. If it covered only
fraudulent third party use of the card data, this guarantee would in effect not go beyond what it
required by law anyway. See supra note 64 and accompanying text.
634
       See    Ebay,    Fraud   Prevention    &    Insurance        (visited    Aug.    17,    00)
<http://pages.ebay.com/help/community/insurance.html>.
635
      See <http://www.gerling.de>.

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                           Enhancing Consumer Confidence: The Rise of New External Institutions


that merchandise is never delivered or that it is defective. Participating shops,

which in return get a “Trusted Shop” seal, pay the premium.636 The consumer

buying from these Trusted Shops gets a money-back guarantee from Gerling if

anything goes wrong in the transaction.


2)          A         Policy          Perspective—Addressing                      Payment
            Intermediaries and Introducing Chargeback Mechanisms
It remains to be seen whether these market approaches—and others that are

sure to come—will be successful. Since they represent reliance mechanisms

they are not subject to most of the doubts expressed above in regard to

information intermediaries trying to foster consumer trust. It is another question,

whether policy makers, who want to accelerate the development of electronic

commerce will or should consider similar approaches. One such example of a

chargeback regime that has been introduced by the legislator actually exists: the

U.S. credit card regulation.


a)          Chargebacks in U.S. Credit Card Regulation

As indicated above, in the U.S. the use of credit cards is mainly regulated by the

Truth-in-Lending Act (TILA)637 and the Federal Reserve Board’s implementing

Regulation Z.638 These regulations go beyond protecting the consumer from




636
      See Trusted Shops <http://www.trustedshops.de>.
637
      See supra note 59.
638
      12 C.F.R part 226 (1999).

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                           Enhancing Consumer Confidence: The Rise of New External Institutions


liability for unauthorized use of her credit card or credit card data.639 Regulation

Z’s billing error resolution procedure 640 allows the consumer to contest a billing

statement that reflects a charge for property or services not accepted by the

consumer or not delivered to the consumer as agreed.641 If this error is

ascertained in the resolution procedure, the card issuer has to credit the

consumer’s account with the disputed amount.642 One important consequence of

this procedure is that it protects the consumer against being charged for goods or

services that she never received or that were otherwise not delivered or

performed as agreed. The procedure affords cheap redress to consumers who

did not get what they paid for with their credit card.


b)          Chargebacks as a General Enforcement Model

The chargeback mechanism in U.S. credit card regulation is unique in two

regards. It does not exist anywhere else in the world,643 and even in the U.S. it

does not apply to any other payment system. While the credit card regulations in

most countries are similar regarding unauthorized payments, they are not in

regard to transactions that go wrong after a payment has actually been



639
      See supra note 64 and accompanying text.
640
   See supra note 638, § 226.13. See generally LAWRENCE, supra note 67, at 526 (giving an
overview on the billing error resolution procedure).
641
      See supra note 638, § 226.13(a)(3).
642
   See id. § 226.13(e)(1). The card issuer will generally pass its loss on to the merchant. See
supra note 67 and accompanying text.
643
   See OECD, Consumer Redress in the Global Marketplace: Chargebacks, OCDE/GD(96)142,
at 54-71, available online at <http://www.oecd.org//dsti/sti/it/consumer/e_96-142.pdf> [hereinafter


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                         Enhancing Consumer Confidence: The Rise of New External Institutions


authorized by the consumer. Under the laws of other countries the card issuer

does not pay any attention to defenses or claims of the cardholder stemming

from her transaction with the merchant.644 The cardholder will be charged when

she authorized the payment. Whether she actually receives the goods she paid

for or not is a problem to be resolved solely among her and the merchant. In this

regard the laws are thus much less favorable to consumers than in the U.S.


The crucial middle position of payment intermediaries and their ability to

guarantee effective and cheap redress to consumers and thereby foster

consumer reliance, however, suggests that the adoption of mandatory

chargeback regimes in cases of problems in the underlying transaction between

the consumer and the merchant might generally be advisable from a policy

perspective.645


Payment intermediaries are typically linked to both parties directly or indirectly

through contracts or a chain of contracts, which gives them an opportunity to

verify the identity and locate the whereabouts of both the merchant and the

consumer. They have a significant leverage on the merchant, because it is the



OECD, Chargebacks] (providing an overview on the situation regarding chargeback regimes in
the OECD member countries).
644
   The same is true for voluntary industry codes. See id. at 7 (“Chargebacks are more likely in
cases of fraud or billing disputes. Some card companies still appear reluctant to offer
chargebacks in cases of dispute about misrepresentation or nonconformance of goods.”).
645
   This question is also raised by Rothchild, supra note 31, at 977 (“The establishment of a
comprehensive international chargeback regime will greatly enhance consumers’ willingness to
enter into online transactions with distant sellers, and will provide consumers with an avenue of
redress.”); ACCC, Enforcement Challenge, supra note 28, at 25; Heckman, supra note 113, at 2.8
(pointing to existing intervention of credit card companies as a possible model for new


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                           Enhancing Consumer Confidence: The Rise of New External Institutions


only party the merchant—if it wants to get its money, which is typically the

ultimate goal for both honest and fraudulent merchants—really depends on. The

payment provider can use this leverage to contractually provide for a right to

charge back amounts to the merchant that it (the merchant) is not entitled to

keep.646 Ultimately, the payment provider could use its leverage to terminate their

service to specific merchants, which would effectively cut these merchants off the

revenue stream and would induce them to comply in the first place. On the other

hand payment intermediaries are in a position that allows them to afford

consumers quick and cheap redress by simply reversing the payment transaction

and recrediting the disputed amount back to their account. Such chargeback

mechanisms can effectively mitigate the risk of prior performance.647 This risk is

the reason for consumers’ vulnerability in distance transactions and the main

factor that leads to a need for trust and reliance in this context. Payment

providers thus are well suited to step in and fix things for the consumer if they go

wrong. They could provide effective enforcement and serve as a basis for

consumer reliance and avoid the high information costs connected with attempts

to enhance consumer trust.


On the other hand, the risks of misuse of chargeback mechanisms by consumers

seem manageable. In the case of tangible products merchants can use delivery




intermediaries facilitating consumer redress). For a comprehensive summary of a respective
round-table discussion see OECD, Chargebacks, supra note 643.
646
   Which is the common procedure in cases of unauthorized use of credit card data. See supra
note 67 and accompanying text.
647
      See supra note 93.

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                       Enhancing Consumer Confidence: The Rise of New External Institutions


services providing a delivery confirmation to prevent consumers from falsely

alleging that the merchandise has never arrived. The merchant could provide this

confirmation to prevent a chargeback. In the case of digital products or services

that are delivered online the problem does not seem to exist. The merchant can

simply transmit the data again. The consumer, should she in fact already have

received the data, could always make an additional copy anyway. So re-sending

the data does not hurt the merchant—and the consumer would actually have no

incentive to falsely state that she has not received anything. Regarding

merchandise that did arrive but allegedly is defective, things are a little more

complicated since a delivery confirmation will normally not give any information

about the condition of the goods that have been delivered. Here the chargeback

could be afforded under the condition that the consumer provides a confirmation

that the goods have been returned to the merchant.


In any event, a chargeback would not preclude the merchant from contesting the

consumer’s allegations in court. Chargebacks in effect do nothing else than

shifting the burden of having to take legal action in the event of a dispute648 back

to the merchant,649 which arguably is the party that is better equipped to bear that

burden in the first place. Since the threat of bringing suit by a merchant is much

more credible than the same threat by a consumer, consumers will generally be

discouraged from misusing chargeback mechanisms to cheat a merchant.




648
   Which has been allocated to the consumer by her having to perform in advance, see supra
note 99 and accompanying text.


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                        Enhancing Consumer Confidence: The Rise of New External Institutions




649
    ACCC, Enforcement Challenge, supra note 28, at 25 (“the burden is taken off the consumer to
initiate lawsuits and placed on the merchant”).

                                             159
                                                                          Conclusions




IV.     CONCLUSIONS

Consumers will not engage in impersonal exchange unless they either trust the

merchant they are dealing with and believe that everything will go alright or they

can comfortably rely on a third party to effectively afford them redress if things go

wrong. Trust and reliance, which are to a large extent grounded on expected

compliance and effective enforcement, are two distinct components of consumer

confidence. This paper has discussed why traditional bases for trust and reliance

are no longer effective in the electronic marketplace. It argues that new

institutions will emerge to enhance trust and reliance, namely information

intermediaries and payment intermediaries, respectively. Of these two options,

reliance mechanisms that can guarantee cheap and effective enforcement of

consumer rights ultimately appear to be the more efficient approach to overcome

the lack of consumer confidence.


The paper has shown that some of these reliance mechanisms have developed

in the market and it has pointed out the crucial role of payment intermediaries in

every online transaction. From a policy perspective it has suggested to leverage

this role and consider addressing payment intermediaries by introducing

comprehensive chargeback regimes that could guarantee effective consumer

redress if something goes wrong in the transaction between merchant and

consumer.


One puzzle, however, seems to remain unsolved. A chargeback regime similar to

the proposal made in this paper in fact does exist in U.S. credit card regulation. If
                                        160
                                                                          Conclusions


that is so, however, why is the lack of consumer confidence not a purely non-

U.S. problem? There are two answers to this question. First, electronic

commerce is doing significantly better in the U.S. than in other parts of the

world.650 This paper asserts that this difference is partly due to the fact that U.S.

consumers do have greater confidence in shopping online because of the more

favorable legislative framework for credit card payments. Second, consumers’

fear of being defrauded by an unknown merchant is not the only inhibitor of

electronic commerce. The other two major concerns of consumers are security

and privacy. These two concerns prevent a significant number of users to use

their credit card online at all. Thus, while the credit card chargeback regime could

in fact give consumers greater confidence in regard of consumers’ fears of fraud,

the other two concerns prevent consumers from using their credit card and

benefiting from the former. The three issues therefore are interdependent and

need to be addressed as such. An important step in addressing the issues is

consumer education. At least consumers’ fears of being liable for an

unauthorized use of their credit card data after a security breach are, from a legal

point of view, irrationally exaggerated651 and presumably due to a lack of

knowledge about the legal risk allocation, which is in effect extremely favorable to

consumers. The privacy issues, being the remaining major obstacle to consumer

confidence, need to addressed aggressively by the private and the public sector.




650
      See supra note 12.
651
      See supra note 77.

                                        161
                                                                     Conclusions


As to the obstacles to consumer confidence that have stood in the center of this

paper, however, chargeback mechanisms appear to be a powerful remedy.

“[C]onsumers must have confidence ... that they will get what they pay for, and

that recourse or redress will be available if they do not.”652 Chargeback

mechanisms appear to be a tool that can guarantee the latter. Therefore the

paper argues that they are an approach worth pursuing in order to overcome “the

global enforcement challenge” presented by the new online marketplace.




652
      See supra note 15.




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